Republic, a Holdout in Refund-Anticipation Loans, Challenges FDIC Order

Republic Bancorp Inc. is fighting to keep a right that most other banks have surrendered.

The Louisville, Ky., company is preparing to square off against the Federal Deposit Insurance Corp. over refund-anticipation loans, a product that regulators have pressured several other lenders to stop making because it is viewed as predatory. Scrutiny of such loans is likely to increase with the creation of the Consumer Financial Protection Bureau.

It will be a tough battle, analysts said, but one worth waging. Given Republic's health — it has been profitable throughout the downturn and is exceedingly well capitalized — it has a better chance than most against the FDIC, which claims the product, often used by low-income individuals, is unsafe and unsound.

"Their condition should give them a lot of staying power," said Jeffrey C. Gerrish, a partner at Gerrish McCreary Smith. "I think most banks would just say 'forget it' and move on. I am glad they are challenging it."

Several large banks pulled out of the business after prodding from regulators. For these institutions, the sliver of business was not worth fighting over. Also, in early 2010 the $7.9 billion-asset Pacific Capital Bancorp Inc. sold its refund-anticipation loan business after the Office of the Comptroller of the Currency would not give it permission to make such loans. RALs were Pacific Capital's most profitable business, but its bank's capital had dwindled to a level regulators deem merely adequate, so the company was not in a position to negotiate.

For Republic, the tax business contributes 40-65% of revenues. The refund-anticipation loans make up about a quarter of that segment. It charges consumers $61.22 to immediately get an amount of money equal to their income tax return. The average loan is repaid in 12 days.

The $3.6 billion-asset company has made such loans for 15 years and has no interest in stopping, Steve Trager, its president and chief executive, said Friday. Despite consumer advocates' depiction of the product, Trager said it is reasonably priced and in demand.

"We charge a one-time fee of $61.22. That's it. That is less than my cellphone bill," he said. "There are millions of taxpayers who demand that product and we've provided it very successfully."

Last week the FDIC issued Republic Bank and Trust Co. a notice of charges for an order to cease and desist and a notice of hearing. At the crux of the notice is the FDIC's assertion that the product is unsafe and unsound because the Internal Revenue Service said last year it would no longer give refund-anticipation lenders data about borrowers such as tax liens from unpaid child support or student loans. The IRS' rationale was that electronic filing has dramatically narrowed the window between filing and issuing a refund, making RALs unnecessary.

The FDIC and the IRS declined to comment for this story.

With the bank not planning to consent to the order, Republic and the FDIC will go before an administrative law judge in 60 days, meaning Republic's tax business will likely not be interrupted before the end of this year's tax season.

Trager said that although the IRS debt indicator is a useful tool, his company made do without it. Republic tightened underwriting standards and mitigated risk by capping the loans at $1,500. The IRS estimates the average return to be $3,003 this year.

So far, the tightening has worked, Trager said. "We are a good chunk of the way through tax season and all of our underwriting is proving to be as strong as we expected," he said. "That is the best way for us to be judged on this matter — our actual performance."

Given the 12-day average repayment for RALs, and the fact that tax season ends two weeks after the end of the first quarter, it should be apparent by the time of the hearing if Republic tightened its standards sufficiently. "The results for the first quarter will be in by then and if they are outstanding, I wonder if the FDIC will have a leg to stand on," said Ross Demmerle, an analyst at Hilliard Lyons.

Demmerle and other experts say the social taint of the product could ultimately overshadow Republic's ability to prove that it can still safely offer the product without the debt indicator. "The regulatory bodies don't like this product and the administrative law judge only makes a recommendation. The FDIC can still say 'no,' " said Terry Keating, a managing director at Amherst Partners, a Chicago investment banking firm. "Even if Republic wins in the short run, there are long-term worries about the business, too."

The administrative law judge will make a recommendation to the FDIC board. Should the board decide to uphold the notice, Republic can appeal.

Trager said he is optimistic about his chances in court.

"I have faith in this country that reasonable minds can differ and that regulatory agencies can't dictate without some accountability," Trager said. "I have faith that there is an ability for us and other institutions to seek objective arbitration on issues we disagree on."

In this downturn, banks have rarely taken challenges to an administrative law judge. In June 2009, Frontier State Bank in Oklahoma City challenged the FDIC's order to change its business model. Though the administrative law judge has made his recommendations, the FDIC board has yet to act.

William McMurrey, a partner at Bracewell & Giuliani LLP who represented Frontier, said the recommendations were not simple. "These cases are not a win-lose situation," McMurrey said. "Everyone is trying to find the best possible solution."