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Monday, Dec 27, 2010 9:09 PM UTC

H&R Block loses tax refund loan banking partner

Millions of customers who rely on short-term loans backed by expected tax refunds will be without them this year

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Topics: Bank Bailouts, Bank Reform, Wall Street,

Millions of H&R Block Inc. customers who relied on short-term loans backed by their expected tax refunds will not have that option this year, since Block’s banking partner was forced by federal regulators to stop offering the loans.

It’s a blow to Block, the nation’s largest tax preparation company, which could lose tax customers to competitors still offering the loans and has virtually no time to find a new funding partner before tax season starts in January.

That means Block could lose millions of dollars in revenue, since nearly 45 percent of its customers use a refund anticipation loan or refund anticipation checks. The company made about $146 million on the two products in 2010.

RALs, often referred to as “rapid refunds,” are short-term loans backed by an expected federal income tax refund. A refund anticipation “check” is actually an account where a refund is deposited. This enables taxpayers to have their tax return preparation fees deducted from their refund, rather than paying up front. Both products are typically used by low-income customers who file their taxes early in the season.

Block’s contract with HSBC Bank to back its RALs dates to 2005, but bank regulators ordered HSBC to stop funding the high interest loans, which typically are offered to customers with spotty or no credit histories. A spokesman for the federal Office of Comptroller of the Currency, the Treasury Department agency that regulates national banks, would not provide any explanation for the directive, stating that such actions by the agency are confidential.

It is likely that a change in policy this summer by the Internal Revenue Service contributed to the OCC’s decision. The IRS eliminated a code that let tax preparers know if customers will get their entire refund, or if some will be held to cover things like unpaid back taxes. Tax prep companies used the code as a form of credit check for the loans.

After the IRS announced its policy change, HSBC tried to pull out of the contract with Block, which prompted the tax preparer to file a lawsuit. Block said in a statement released Friday that negotiations related to the suit had led to an agreement calling for HSBC to fund the loans for the 2011 tax season with Block covering any defaults. That deal was blocked by the OCC action.

Block said the proposed new terms would have made it nearly impossible for HSBC to suffer any financial losses, potentially a big issue for regulators.

“As a result of the OCC’s decision, millions of taxpayers will be deprived of credit, or they will be forced to use higher?priced alternatives, without the slightest benefit to the solvency of HSBC or the banking system in general,” Block CEO Alan Bennett said in a statement. “While we are very disappointed by this decision, we have been preparing for the loss of RALs, so we have several other financial products available and under development for this tax season.”

He said while the company is working to provide other options, the OCC’s last-minute action makes it difficult to put alternative products in place at all locations in time for the early part of the 2011 tax season.

Block said it will continue to offer customers refund anticipation checks, which are funded through H&R Block Bank, along with direct deposit accounts through its Emerald Card program.

Block also provides other programs to its tax preparation clients, such as its Emerald Advance revolving line of credit. Lines of credit have been used by more than 4 million customers, the company said. But during a conference call last month the company said they would not be used to replace RALs.

Oppenheimer & Co. Inc. analyst Scott Schneeberger said in a worst-case scenario, Block could see up to a 7 percent drop in its tax preparation volume in the 2011 season, compared with this year. But he expects a 4 percent loss is most likely. That would cut Block’s 2011 profit by 13 cents per share to $1.44, from an earlier forecast of $1.57. Analysts surveyed by Thomson Reuters expect $1.61.

Schneeberger maintained a “Perform” rating on the company.

Block shares tumbled 89 cents, or 7 percent, to $11.80 in afternoon trading.

It’s expected some of Block’s customers may switch to a competitor still offering RALs. Jackson Hewitt Tax Service Inc. said on Dec. 17 it had secured funding that allows it to offer refund anticipation loans for the upcoming tax season. Jackson Hewitt amended its agreement with Republic Bank & Trust Co. to allow 80 percent of the expected refund anticipation loans. That gives the No. 2 tax preparer a leg up on main competitor Block.

The stock of the Parsippany, N.J., company surged 44 cents, or 25 percent, to $2.21.

Privately held Liberty Tax Service has also said it will offer refund loans.

In a note to clients, Schneeberger pointed out that the regulatory action could set a precedent that also hits competitors’ refund loan funding, or Block could try to “muscle-in” on the banks backing their loans.

——–

David Pitt reported from Des Moines, Iowa.

More Eileen Aj Connelly.

More David Pitt.

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