Profits from tax refund anticipation loans, a controversial and once-lucrative product for underbanked consumers, are drying up.
Consumers have been less willing to pay extra for faster refunds in the recession. Long-running advocacy campaigns against the loans have increased the legal and reputational risks of offering them. Proposed regulatory reforms in Washington would tighten scrutiny of the loans. And the Internal Revenue Service is updating its computer systems to process refunds more quickly.
All these factors contributed to a sharp decline in loans made this past tax season, as consumers shifted to a cheaper, less controversial financing product often called the refund anticipation check.
Industry executives and observers said the business may not recover.
"I think it'll be permanent. I think people are moving away from the RAL and towards other products," said Steven Trager, the chief executive of Republic Bancorp Inc. in Louisville, one of a handful of financial institutions that offer the loans through tax-preparation firms.
Industrywide, taxpayer requests for refund anticipation loans fell by more than 15% in the 2009 tax-filing season, to 8.4 million, according to a report published in June by the Government Accountability Office. Demand for refund anticipation checks rose at the same time: 11.5 million taxpayers requested them this year, 10% more than a year earlier.
Like the loans, refund anticipation checks let consumers pay for tax-preparation services without any out-of-pocket expense. (And both products give consumers without bank accounts the speedy access to their refunds that is normally only available via direct deposit.)
With both products, the tax preparer or its financial institution deducts the fees for the return, and additional fees for the loan or check, from the refund amount that ultimately reaches the consumer.
The loans have the additional selling point of getting cash in the consumer's hands faster — the bank funds them within days or even an hour. The checks, on the other hand, are not written until the IRS sends the refund, usually in about two weeks.
But the checks also cost about half as much as the loans. HSBC Holdings PLC and JPMorgan Chase & Co., for example, charge about $62 for an average loan of $3,000; Republic and Pacific Capital Bancorp charge more than $100. Most refund anticipation checks cost about $30.
Fewer consumers qualified for refunds this year, and those who did were willing to wait longer to get their cash in order to pay less, industry executives and observers said.
Last week the $7.3 billion-asset Pacific Capital said its profit from the sale of refund anticipation loans and checks was cut almost in half from a year earlier, to $61.3 million — even as the number of products sold remained relatively flat at 8.1 million.
Pacific has attributed the drop in profits largely to a change in IRS standards that resulted in more refunds being denied after loans were funded, forcing the lender to charge off the loans. But the Santa Barbara, Calif., company also reported a shift in consumer demand away from its loans and toward its check product. The product mix in the first quarter was 23% loans and 77% checks, as opposed to the 27%-73% split a year earlier. (Pacific did not respond to interview requests by press time.)
Trager reported a similar shift in consumer preference at Republic this year: its tax product mix is usually one-third loans and two-thirds checks, but the amount of loans sold fell about three percentage points this year, to 30% of its products sold, as more consumers shifted to the check. "The mix was more tilted towards the less-expensive product," he said. "People are sensitive to the economy and the pricing."
The consumer switch to cheaper but slower refund products seemed counterintuitive to some.
"It is kind of a surprise to me and a lot of people in the industry. In this economy, you would think people would want to get the money as quickly as possible," said Todd Young, an analyst for Morningstar Inc. who covers tax-preparation companies. "In the past customers hadn't really been that price-sensitive at all. But there have been a lot more consumer advocacy groups out there saying, 'Hey, you're really wasting your money' " with a refund anticipation loan.
John Caskey, an economics professor at Swarthmore College, agreed that the drop in demand for the loans is partly a result of a "big push by nonprofit groups as well as state and federal agencies" to educate consumers and provide free tax services.
That push has also generated public relations headaches for the big tax-preparation companies, which "have received a lot of criticism," Caskey said.
"In particular H&R Block has been trying to improve its image. It's possible that they're not pushing it as hard as they used to."
Indeed, Richard Breeden, H&R Block Inc.'s chairman, reportedly told investors in January, "RALs are doing a pretty good job of killing themselves."
Republic has stumbled into some of the regulatory pitfalls surrounding the product. In February the $3.1 billion-asset banking company received a cease-and-desist order from the Federal Deposit Insurance Corp. over the loans and its monitoring of the third-party providers that sell them to consumers. (Republic offers the loans and checks through about 12,000 tax providers, including Jackson Hewitt Tax Service Inc. and JTH Tax Inc., which does business as Liberty Tax.)
A spokeswoman for JPMorgan Chase, which offers loans and checks through about 13,000 independent providers, said "it's a good business for us" but would not discuss specific results from the business.
A spokeswoman for HSBC also would not discuss specifics, but noted that it has "proactively reduced its partners and products over the last two years," and now only offers the loans through H&R Block.
Young said he expects HSBC to fully exit the business after its contract with H&R Block expires.
"HSBC pulled out with Jackson Hewitt and the others after their contracts expired … so it looks like an industry that HSBC is looking to get out of," he said. (HSBC would not comment on "speculation.")
Chi Chi Wu, a staff attorney for the National Consumer Law Center in Boston and a longtime critic of both refund anticipation loans and checks, said she would "like to think" that demand for the loans has fallen because "taxpayers have realized that they're not a good proposition."
But she acknowledged some reforms within the industry. At JPMorgan Chase and HSBC, "the prices are lower, their disclosures are standardized," Wu said. "We'd still like the prices to come down to be under 36%" on an annual percentage-rate basis, but "we haven't seen the big problems that we've seen with independent preparers and Jackson Hewitt and Liberty." (Jackson Hewitt and Liberty each offer loans from both Republic and Pacific.)
Wu was among those who signed letters sent to the Office of the Comptroller of the Currency in April and July calling for more strenuous regulation of RALs, and for more actions akin to the FDIC's crackdown on Republic. The July 13 letter said, "Given the history of consumer law violations and tax fraud by tax preparers partnering with Pacific Capital … we have serious doubts that this OCC RAL-lending guidance is being complied with." (The OCC, which has directed Pacific to maintain higher capital ratios, would not discuss the company.)
The Obama administration's proposed Consumer Financial Protection Agency would have jurisdiction over tax preparers, as the House bill to establish the agency is currently written.
Tax professionals attributed that regulatory interest to products like refund anticipation loans.
"It would be much broader than just refund anticipation loans, but we believe that the reason tax preparers were brought under the bill was refund anticipation loans," said Thomas P. Ochsenschlager, the vice president of taxation at the American Institute of Certified Public Accountants, a trade group.
H&R Block, Jackson Hewitt and Liberty are not members of the trade group. None of them responded to requests for comment for this article.
On a conference call in June — before the administration unveiled its full proposal for the consumer protection agency — Harry Buckley, the president and CEO of Jackson Hewitt, said in response to an analyst question about the loans: "The current administration … keeps talking about enforcing new banking regulations that could tie the hands of maybe our financial partners. … We've wondered for years just how long this thing was going to last and we continue to do so."
Even short of a ban on the loans, consumer advocates said the proposed agency could toughen oversight.
The House bill "doesn't specifically say, 'There will be no RALs,' and the agency doesn't have the authority to institute usury caps, but it'll be a question of what the agency does," Wu said. "We suspect that an agency that focuses specifically on consumer protection will be better on RALs than banking regulators."
In the end, the longest-lasting suppressant of consumer appetite for refund anticipation loans may be the most prosaic one: faster technology.
The IRS has started overhauling its system for processing refunds, to shorten by one to eight days the waiting period to receive a direct deposit for most people who file their returns electronically.
Those updates are on hold, according to the GAO. "They did suspend work for a while and we're not sure when it's going to start up," said James R. White, the GAO's director for tax issues, who oversaw the June report. "The IRS is rethinking. The issue they've got is: the easiest returns are getting processed on there now, and it's getting harder and harder to expand this. For the more complicated returns, there's a lot more programming" required.
The IRS would say little about the project. Spokesman Robert Marvin said Friday, "We are continuing to work on our modernized database and we are making progress as we seek to expand it."
Of course, faster direct deposits would have little impact on consumers who do not have a bank account to receive them. But White, like other observers, said that once completed, the new technology will have "some influence on RALs … the faster IRS can turn refunds around, for RALs, the less demand."