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| ## Comptroller of the Currency                                        |
|                                                                       |
| > Administrator of National Banks                                     |
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Washington, DC 20219

##### Interpretive Letter #959

February 13, 2003 **March 2003**

Dear **\[ \]**:

This letter responds to your letter dated August 6, 2002, concerning the
risk weight for tax refund anticipations loans (RALs) and the timing for
reporting capital ratios. With respect to the risk weight for RALs, the
OCC has determined that 100 percent is the appropriate risk weight for
this type of consumer lending. With respect to reporting, capital ratios
are regularly reported on each quarterly Consolidated Reports of
Condition and Income (Call Report). However, additional reporting
requirements, which are described below, apply if a material event
occurs that could cause a bank to be placed in a lower capital category.

**Background**

**\[ \]** (the Bank), has requested that the OCC consider a risk weight
of 20 percent for RALs and has provided a legal opinion arguing the case
for a lower risk weight.

RALs are bank loans made to individual taxpayers in anticipation of tax
refund payments. To apply for a RAL from the Bank, the taxpayer must
retain tax preparation services from an IRS-approved *e-file* tax
preparer with which the Bank has an agreement, open a deposit account at
the Bank, and direct the refund to that account. The account, which the
Bank controls, is set up for the sole purpose of receiving the
electronic refund from the IRS. The bank account is required because the
IRS will not pay a refund to a third party even though the IRS provides
guidelines for RAL programs.

The Bank charges a RAL borrower an application fee, a finance charge,
and, if applicable, an Earned Income Tax Credit fee. The RAL borrower
also pays tax preparation, *e-file*, and other fees to the tax preparer.
Based on an average maturity of 10 days, the APRs for RALs with EITC
ranged from an estimated 66.15 percent for a \$5,000 RAL to an estimated
1880.3 percent for a \$100 RAL according to the Bank's 2000 RAL
application.

The Bank limits the amount of a RAL to \$5,000 and further limits the
amount of a RAL covered by an EITC refund to \$1,200. The Bank will not
make the RAL until the IRS provides a Debt Indicator (DI) that verifies
that there are no federal claims outstanding on the tax filer. If the DI
indicates the IRS will offset the tax refund, the Bank rejects the RAL
application and only provides the deposit account and refund transfer
services. Delinquent RALs from any prior year are deducted from the
current refund due per an agreement among other banks that have RAL
programs.

Activity in the Bank's RAL program generally begins in mid-January,
peaks in early to mid-February, and is virtually completed by the end of
March. At the end of the second quarter, the Bank writes off the
balances of any outstanding RALs. According to the Bank, past experience
indicates that 1.5 percent of RAL borrowers manage to circumvent
controls put in place by the IRS and the Bank, which results in losses
to the Bank.

In November 2000, the Bank set up a special purpose subsidiary
corporation for the purpose of securitizing RALs. In the first quarters
of 2001 and 2002, the Bank sold some of its RAL assets into this
conduit. By the end of the second quarter in each year, the
securitization balances were reduced to zero. In 2002, the Bank retained
an 8 percent first loss position in the RAL assets it sold to the
conduit.

In the opinion of the Bank's outside counsel, a zero risk weight might
be appropriate but counsel does not press the case. Rather, the legal
opinion argues for a 20 percent risk weight on the basis that the RAL
Program is (1) effectively collateralized by a direct obligation of the
U.S. Government and (2) a 20 percent risk weight is prudent and
consistent with regulatory intent. The legal opinion argues that the
Bank's perfected security interest in the RAL borrower's bank account is
the equivalent of an ownership interest in a claim on the U.S.
Government. The opinion also suggests that RALs are analogous to general
obligations of states and other political subdivisions, instruments
conditionally guaranteed by the U.S. government, and obligations
guaranteed by Fannie Mae or Freddie Mac. Citing the OCC's reservation of
authority[^1], the opinion further argues that the OCC can determine
that RALs merit a 20 percent risk weight even though the U.S. government
does not actually guarantee a RALs transaction.

**Discussion**

**Risk Weights** - The OCC's risk-based capital regulations permit a 20
percent risk weight for assets that are "conditionally guaranteed by the
United States Government or its agencies"[^2] or are "collateralized by
cash or securities issued or directly and unconditionally guaranteed by
the United States Government or its agencies...\[and do\] not qualify
for the zero percent risk weight category."[^3]

Lowering the risk weight on RALs from 100 to 20 percent relies primarily
on the OCC's concurrance with the Bank's position that the IRS
conditionally guarantees payment of a tax refund claimed by an
individual taxpayer, which effectively guarantees the repayment of a
RAL. Despite the arguments in the Bank's legal opinion, the Bank's
actual loss experience suggests RALs do not perform as if the U.S.
government guarantees them. The Bank has taken a number of steps to
minimize losses including perfecting a security interest in the deposit
account of the RAL borrower, requiring a positive DI from the IRS before
making the RAL, providing incentives to tax preparers based on above
average-screening of tax returns and RAL applications, and signing the
recovery agreement with other banks that offer RALs. Nonetheless, the
Bank's losses are larger than would be expected in the case of a U.S.
government guaranteed obligation. **\[ \]**'s 10Q for March 2002
describes the risks and losses as follows:

There is a higher credit risk associated with refund loans than with
other types of loans because (1) the Company does not have personal
contact with the customers of this product; (2) the customers conduct no
business with the Company other than this once a year transaction; and
(3) contact subsequent to the payment of the advance, if there is a
problem with the tax return, may be difficult because many of these
taxpayers have no permanent address.... Credit risk has been lowered in
the last three years because of the debt indicator provided by the
IRS.... However, the charge off rate for RALs still remains
approximately five times higher than for the rest of the Company's loan
portfolios. (page 43)

Furthermore, the IRS does not compensate the Bank for any losses that it
has incurred. In the section of the [IRS e-file Handbook]{.underline}
that discusses RALs, the IRS specifically states that the "Department of
the Treasury is not liable for any loss suffered by taxpayers, EROs, or
financial institutions resulting from reduced refunds or Direct Deposits
not being honored causing refunds to be issued by check."[^4] The IRS
also does not recognize the assignment of the payment of individual tax
refunds to a third party. The extension of credit through a RAL relies
primarily on information provided by the individual filer. If the IRS
determines, pursuant to its statutory discretion, that the tax return is
not accurate and reduces or denies the expected refund claim, the
repayment of the RAL defaults to the individual's creditworthiness.
Furthermore, there is no contractual relationship between the Bank and
the IRS establishing any form, express or implied, of government
guarantee. Accordingly, the Bank's RAL program does not meet collateral
or guarantee provisions that would qualify RALs for a 20 percent risk
weight. Nor does the RAL program have the characteristics that would
make RALs analogous to general obligations of municipalities and assets
issued by other entities that qualify for a 20 percent risk weight.

**Reporting** -- In addition to the requirement to report capital levels
and ratios in quarterly Call Reports, the OCC's Prompt Corrective Action
regulations[^5] require notification if a material event occurs that may
result in a lowering of the bank's capital level or capital category. If
a bank determines that such an event may have lowered its capital
category, the bank must notify the OCC in writing within 15 calendar
days. The OCC will then determine whether the bank's capital category
should be changed and advise the bank accordingly.

**Conclusion**

Based on a review of the Bank's RALs program and the request for a lower
risk weight, the OCC has determined that 100 percent is the appropriate
risk weight for this type of consumer lending. In an August 6, 2002
letter, the Bank states, "We have been told that we may assign RALs
other risk-weightings we consider appropriate when capital ratios are
computed at times other than at calendar quarter's end." This is not
correct. For regulatory capital purposes, the risk weight for RALs is
always 100 percent, whether the calculation is at quarter end or
intra-quarter.

Furthermore, if the Bank determines that a material event has occurred
that may lower the Bank's capital category, the Bank must notify the OCC
within 15 days of that event. The Bank's notification, pursuant to this
requirement, that such an event may have occurred does not, in and of
itself, constitute in a change in a capital category.

#### Additional Significant Issue

During our review of your request, an additional significant issue
related to the Bank's securitization of RALs came to our attention.
Revised risk-based capital rules for asset securitizations were
published on November 29, 2001 (66 FR 59614; [see]{.underline} OCC
Bulletin 2001-49). These rules determine the capital charges that apply
when a bank sells an asset and retains a larger than *pro rata* share of
the credit risk associated with that asset. Among other things, the
revised rules provide for a dollar-for-dollar capital charge on unrated,
first loss positions retained on securitized assets. For example, if the
Bank sells RAL assets into a conduit and retains a first loss position
on its balance sheet, the risk-based capital charge will equal at least
the carrying value of the retained position, regardless of the
risk-weights of the underlying assets.

If you have questions or need additional information, please contact
Nancy Hunt at (202) 874-5070.

Sincerely,

/s/ Tommy Snow

Tommy Snow

Director, Capital Policy

[^1]: 12 C.F.R. Section 3.4(b).

[^2]: 12 C.F.R. Part 3, Appendix A, Section 3(a)(2)(v).

[^3]: 12 C.F.R. Part 3, Appendix A, Section 3(a)(2)(iv).

[^4]: [IRS e-file Handbook]{.underline}, Publication 1345 (Rev. 1-2001),
    Internal Revenue Service, Department of the Treasury, p. 51.

[^5]: 12 C.F.R. Section 6.3(c).