H&R Block Goes Back on the Block

Tax preparer H&R Block (NYSE: HRB  ) is finding out it's not so easy to get out from under government oversight.

Source: SXC.hu.

Following passage of the Frank-Dodd Act of 2010, non-bank "banks" like Block, Allstate (NYSE: ALL  ) , and MetLife (NYSE: MET  )  found life as a financial services provider very different as the new rules required savings and loan holding companies, as they were deemed, hold significantly higher levels of capital than they previously had to. Block, which owns H&R Block Bank, hired Goldman Sachs to help see its way out of the morass of tighter scrutiny and regulation.

This summer, the tax prep firm announced it had entered into an agreement with Republic Bancorp (NASDAQ: RBCAA  ) to sell its banking business to the bank and, separately, to market its branded tax prep services to Republic's customers. At the end of the transaction, H&R Block would surrender its banking charter and be rid the yoke of Federal Reserve Bank oversight.

One of the conditions of the deal, though, was for Republic to apply to become a national bank. It subsequently applied to the Office of the Comptroller of the Currency to merge and consolidate its Republic Bank & Trust and Republic Bank charters into one national bank charter.

Thirty-nine of Republic's locations operate under a charter granted by Kentucky, and those locations are regulated by the FDIC. Its five Florida bank's branches operate under a federal charter and are regulated by the Office of the Comptroller. Aside from the asset purchase agreement with Block, the move made additional sense because it would be easier for it to open branches while saving money because the bank would report to only one national regulator.

But Republic notified H&R Block yesterday that it decided not to move forward with the consolidation, which caused the tax prep firm to call off the deal. Both sides expressed disappointment in the cancellation of the transaction, though Republic refused to say why it wasn't going through with its portion of the plan. It's a blow to both sides, really.

Block, of course, now has to go back to the drawing board and dial up other parties it may have identified as being interested in its banking business and get the ball moving again. It had planned to exit the business by the start of the 2014 tax season.

For Republic, it used to make a bunch of money by offering tax filers refund transfers and refund-anticipation loans -- those "instant refunds" you'd see advertised everywhere. Republic generated $45 million in fees from the loans and transfers in 2012, or 38% of its total revenues, and realized nearly three-quarters of its net income from its tax refund solutions division the year before.. 

However it was forced to drop such services last year in a negotiated deal with the FDIC, which declared such loans "unsafe and unsound." It suffered a second blow when Block's tax prep service rival Jackson Hewitt stopped doing business with the bank.

Through both Jackson Hewitt and its Liberty Tax Service subsidiary, Republic underwrote the RALs and RTs the tax prep services offered to tax filers, realizing 40% of the segment's revenues from RALs and another 20% from RTs. But the tax prep service said since Republic can no longer hold up its end of the bargain and fund the loans and transfers, it was backing out of the relationship. The bank, however, disagreed with the rationale and brought the matter to an arbitrator, where it now sits.

H&R Block also used to offer refund-anticipation loans, but it stopped when its bank, HSBC (NYSE: HSBC  ) , also stopped underwriting them. Republic has been the last bank underwriting them. Thus the deal with Block was seen as key to getting its tax return business back on track.

While Republic hasn't disclosed the reason for backing out, one can easily imagine competing regulators remain concerned about this mix of banking and tax services. It had warned last month the deal wouldn't be done by the end of this year as originally planned, so it's clear the Office of the Comptroller wasn't really keen on moving forward. And now with the new Consumer Financial Protection Bureau supposedly on the consumer's side, sketchy relationships like this are likely to be frowned upon.

In any case, Republic is back on the prowl for a tax prep partner, and H&R Block is putting its banking business back on the auction block. 

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