As the end of the third quarter approaches, Wall Street is focused on one number in Pacific Capital Bancorp’s results: tier one capital.
After Sept. 30, the region’s largest independent banking company and parent of Santa Barbara Bank & Trust will have to show federal regulators that it’s raised its all-important tier one leverage ratio, something it agreed to do in April. Though Pacific Capital still sits above regulators’ minimum thresholds, analysts say any significant loss in the third quarter could push it into a red zone, leaving a capital infusion or merger as the only way out.
Pacific Capital voluntarily agreed with regulators to boost its tier one leverage ratio – its free cash divided by its loans and other assets – to 8.5 percent by June 30. It missed that mark, clocking in at 5.7 percent, a decline from 6.7 percent the quarter before. The bank’s agreement calls for ratio of 9 percent by Sept. 30.
“The one thing I’ll be looking for is their capital levels and seeing where that compares with their [agreement with regulators],” said Julianna Balicka, an analyst with Keefe, Bruyette & Woods. “The real question is what happened to move the capital-raising or finding-a-buyer process forward.”
On those fronts, Pacific Capital is holding a vote of shareholders on Sept. 29 to decide whether to authorize the potential issue of hundreds of millions of new shares. That move could make it logistically easier to raise capital but also could give the bank a weapon to dilute any potential acquirer. The bank has said its move wasn’t in response to any takeover activity, but it has hired Sandler O’Neill, an investment bank, to explore options for getting new investors or merging with a stronger partner.
Pacific Capital also faces two lawsuits from shareholders who allege they were harmed because the bank’s leadership hid bad news about real estate loans gone bad until the massive second quarter loss, sending share prices sharply downward. Pacific Capital denied the allegations, but observers are mixed as to whether the suits could hamper a merger.
Pacific Capital’s losses have stemmed from writing down loans and the money it’s had to put away to cover troubled loans that may not pay. Though top bank officials admit they made a mistake in funding construction projects in faraway locales such as Bakersfield and Las Vegas, the bank is in no different position than many of its peers when it comes to the crash in real estate values.
“Nobody imagined the magnified nature of the real estate decline,” George Leis, Pacific Capital’s chief executive, said during a gathering of bank and community leaders in Thousand Oaks on Sept. 22. “We had a loan in Monterey on prime property that was $21 million, and it was appraised at $1.2 million. We had to write it all the way down because there were no comps, no comparable sales.”
But there is evidence that Pacific Capital has recognized its problems and put away reserves to cover them. The bank’s ratio of troubled loans and leases to its reserves was 125 percent at June 30, compared with 170 percent among its peers. That means the bank has more reserves put away relative to its troubled loans than other banks.
“They have been doing their homework,” Balicka said. “A lot of what’s happened to them has been a matter of timing and accounting.”
On the accounting front, Balicka worries that Pacific Capital’s capital position could take a hit because the bank could lose part of its tax shelter on losses at Sept. 30.
Bank officials say they’ve created reserves for that possibility, but Balicka remains concerned that technical accounting factors could drag down Pacific Capital’s tier one leverage ratio, making it easier for a potential acquirer to ask federal regulators to share in some of the risks of a merger.
“Once you lose your tax shield, it’s really an accounting downward spiral,” Balicka said.
“It’s got nothing to do with whether the bank is operating well. It’s one of those accounting situations that puts a bank in a bad spot for a non-operational reason, but it’s still quite dangerous.”
Much of Pacific Capital’s trouble has resulted from new pressure from regulators to push its capital ratios in one direction while the figures moved in the other direction.
“The [Office of the Comptroller of the Currency, Pacific Capital’s regulator] still has a very dark view of the landscape,” Leis said at the banking gathering. “They want institutions to step up capital and liquidity. There’s been a change in the methodology over the past nine months.”
Other banking leaders at the gathering concurred.
“I’ve never seen anything like this from regulators,” said Lynda Nahra, chief executive of Community West Bank in Goleta. “In addition, if you have taken TARP money or you are a public company, you have the Treasury and the SEC breathing down your neck.”
Pacific Capital also faces a new regulatory landscape with its refund anticipation loan program. That business provides taxpayers a loan based on their estimated income tax return. The consumer gets instant cash minus some fees after filing his or her taxes, and the IRS sends the refund to Pacific Capital.
The line of business has proved a crucial component of Pacific Capital’s growth during the past decade, especially since 2002, when the bank began securitizing and selling the refund loans. The surplus capital generated by tax programs in the bank’s heyday provided cash to pay for acquisitions, increased dividends and share repurchases.
Critics of the program say it’s often low-income taxpayers who use the refund loans. When annualized, the interest rates on the loans – which are typically only out for a few days or weeks – look enormous, critics say. They want tighter restrictions on who can get the refund loans and more oversight of the tax preparers who also take a cut of the refund.
The critics also bristle at the thought of a cut from the federal Earned Income Tax Credit – an antipoverty program that gives poor people money via a tax refund – going to a private concern such as a bank, especially one that took federal bailout money.
“On one hand, government money for an antipoverty program is going to a private entity. And on the other hand, TARP money is going in to help it continue as a going concern,” said Adam Rust, research director of the Community Reinvestment Association of North Carolina. “It’s almost like the government is investing in a bank to take money from the government. There aren’t many banks like Pacific Capital.”
But over the years, Pacific Capital has taken steps to ensure that taxpayers who get an “overly large” portion of their refund from the Earned Income Tax Credit don’t take out refund loans. And the bank is unequivocal that no taxpayer money went toward refund loans.
“No TARP funds were used to fund any refund anticipation loans,” said Debbie Whiteley, executive vice president of investor relations and corporate communications at Pacific Capital.
But critics of refund loans may have a new audience in Washington, D.C. In February, the FDIC ordered Kentucky-based Republic Bank to tighten its oversight of its refund loan program, requiring new audits that could make the business less profitable. Rust’s group has sent a letter to the OCC — Pacific Capital’s regulator — asking it to adopt the FDIC’s standards.
Rust, from North Carolina, said that whatever their moral value, refund loans might not be making business sense any more. Write downs happen on the loans when the IRS denies the taxpayer’s refund, which can happen because of mistakes or fraud on the third-party preparer’s part.
Pacific Capital’s write downs on refund loans nearly doubled between 2008 and 2009, from $41 million to $81 million. And part of what pummeled Pacific Capital in the first half of 2009 was a dead securitization market for refund loans. Despite raising more than $1 billion in deposits to fund the loans and securing a $524 million line of credit, the bank still had to take $2 billion of them onto its books, distorting its capital ratios.
“If [Pacific Capital] is making these loans that are shaky in terms of their soundness, and holding all the loans instead of having some sort of securitization, it’s all one more blow toward their tier one capital,” Rust said.