Tax refund lending can be a high-risk business, but as Republic Bancorp Inc. in Louisville showed in the first quarter, it can also be a high-reward one.
The $3.1 billion-asset Republic is coming off its best quarter ever as its profits more than doubled from a year earlier, to $19.8 million, or 96 cents a share. At a time when many bankers are struggling to meet earnings targets, Republic beat the average estimate of analysts by 41 cents.
It attributed the results to a three-year agreement it signed in September to provide refund anticipation loans to customers of Jackson Hewitt Tax Service Inc. Republic has been making the loans for a dozen years, working with various tax preparers, but the Jackson Hewitt partnership, its first with a national firm, helped boost volume.
Another factor working in Republic's favor: Other banking companies have curtailed their refund lending as the practice has come under more scrutiny from the Internal Revenue Service.
"That's certainly opened up some opportunity for us to go out and hand-pick quality customers," said Steve Trager, Republic's president and chief executive officer.
Still, analysts who follow Republic said the company should not lament the end of tax season. Republic's core banking business has benefited from the Federal Open Market Committee's rate cuts, and further cuts should only improve the core bank's net interest margin, which rose 54 basis points in the first quarter, to 3.63%.
Ross A. Demmerle, an analyst with Hilliard Lyons Equity Research, raised his full-year earnings estimate by 80 cents, to $2.25 a share.
The strong first quarter "should be followed by a strong nine months," Mr. Demmerle wrote in a research note issued Tuesday. Some of the tax lending business "flows into the second quarter," and "the net interest margin at the bank level, which is more relevant to the second half of the year, should hold up" and would benefit from any additional rate cuts.
Refund lending accounted for 72% of Republic's first-quarter net income, compared with 51% a year earlier. Michael Lipman, an analyst with First Horizon National Corp.'s FTN Midwest Securities Corp., said that for the full year that percentage could be as much as 30% to 35%, compared with 11% last year.
Republic charges a flat $110 for each refund anticipation loan, though the fee is recorded as interest income. About half the loans are securitized and sold on the secondary market; Republic collects a fee from the sales but remains on the hook if the loans default. (The average loan is about $3,400.)
Refund loans can be risky because because of their potential for taxpayer fraud. Pacific Capital Bancorp in Santa Barbara, Calif., which also has worked with Jackson Hewitt, recorded a $22.4 million provision in the third quarter to cover fraud losses from its refund lending business.
Tax-refund lending has come under increased scrutiny from IRS, which is considering new restrictions on the practice. Still, the IRS has it said it has no intention of banning the loans, though some companies, including HSBC Finance Corp., have pulled back from offering the loans or some forms of them.
Mr. Trager said that he was confident Republic has managed its refund lending risk conservatively, and that it collected on virtually all its refund loans in the first quarter.
"We still have some of those loans outstanding," he said. "But we're well reserved for what we have currently outstanding."
Mr. Lipman said analysts missed estimates by such a wide margin because the refund lending business is "very difficult to model."
The risk is in the collections. If the IRS finds errors in a tax return or suspects fraud then a refund could be less than the amount of the refund-anticipation loan.
The loans are short term, but if they remain outstanding for a long time, Republic does not collect extra interest payments, Mr. Trager said. "It's $110 whether the loan is outstanding 10 days or six months. It doesn't change. We make some attempt to find the folks if their refund doesn't pay the loan. But we don't file any legal action against anyone," because the loans are relatively small.
Republic is looking at ways to turn these short-term customers into long-term ones through credit card offers and issuing refunds on debit cards, Mr. Trager said. So far only about 1,500 customers have opted for the debit cards, which he said could be made to be reloadable.
"That could be a mechanism to expand that relationship," he said. "It's very early on in the process, but like so many payment mechanisms, I'd expect it will grow."
Mr. Trager said that the bulk of the refund loan business comes in the first quarter, and that its expenses generally rise during third and fourth quarters when Republic does its marketing and hires seasonal workers as it ramps up for tax season.
In the meantime, analysts say its core banking business is expected to fare well this quarter and the rest of the year. During the first quarter core bank earnings rose about 24% from a year earlier, to $4.8 million, largely because the Federal Home Loan bank borrowing and brokered deposits it used to fund its loans repriced down when interest rates dropped.
