Applying a tourniquet to its worst bleeding and quelling any immediate concerns over its survival, Santa Barbara-based Pacific Capital Bancorp lost $40.7 million in the third quarter but held its capital position steady.
Federal regulators are keeping a close eye on capital levels at Pacific Capital, the parent of Santa Barbara Bank & Trust and the largest independent banking company in the Tri-Counties. Banks are required by law to have a certain amount of capital on hand, and while Pacific Capital meets the official standard, it’s short of a higher level it agreed to earlier this year.
Going into survival mode after a staggering $362 million loss in the second quarter, Pacific Capital’s more immediate concern this quarter was its liquidity — its ability to repay all its obligations at a decent cost — and analysts say the bank did a good job ensuring it.
But with regulators watching every move the bank makes, big questions loom for Pacific Capital for the fourth quarter and beyond. As it continues to hunt for an investor or merger partner, new rules from the Federal Deposit Insurance Corp. could give the bank a break on a big chunk of troubled loans that are still performing.
And the bank’s controversial tax-refund program, a big moneymaker in the past, remains in limbo for 2010 unless regulators allow the bank to pad out its balance sheet during next year’s tax season.
“Within the areas where they have flexibility, they are definitely dancing a very fine dance,” said Julianna Balicka, an analyst with Keefe, Bruyette & Woods in San Francisco. “But they did it well this quarter.”
Though their decline has halted, capital ratios at Pacific Capital remain a problem. The firm’s tier one leverage ratio – the bank’s free cash divided by its loans and other assets – came in at 5.6 percent, essentially unchanged from the quarter before. But that is still well short of the 9 percent the bank voluntarily agreed with federal regulators to maintain by Sept. 30.
Over the summer, Pacific Capital retained Sandler O’Neill, an investment bank, to help it evaluate options that could include a merger or selling stock to raise capital. But in a conference call with investors the bank made it clear it wasn’t going to provide additional details until or unless a deal is struck.
“Our capital ratios remained relatively stable during the third quarter, and with the help of our outside financial advisors, we continue to actively explore possibilities for further strengthening our capital position going forward,” was all that Chief Executive Officer George Leis would say in a release accompanying the earnings announcement.
Pacific Capital kept its ratios steady through the loss in part by boosting deposits and selling off $86 million in commercial real estate loans and $116 million in residential real estate loans. Total loans were $5.37 billion Sept. 30 compared with $5.65 billion the quarter before, and total deposits were $5.53 billion at Sept. 30 compared with $5.25 billion the quarter before.
“We will continue very aggressively with our deposit campaigns,” Stephen Masterson, Pacific Capital’s chief financial and operating officer, said on a conference call with investors Nov. 3. “That will inevitably increase our cash position.”
But Balicka worries some of those boosts may not be sustainable. A chunk of the deposits came in the form of brokered deposits, which are sometimes called “hot money” because they consist of investors shopping for good interest rates and can be volatile. And Pacific Capital also drew advances on its Federal Home Loan Bank credit line. Both avenues to liquidity have regulatory limits and can’t be relied on forever.
“Then what? It was a necessary move, but it leaves me a little wary,” Balicka said.
Balicka also worries that some problem loans remain unaddressed on Pacific Capital’s books. The bank only lost $1.3 million on the loans it sold off this quarter, but those were solidly performing loans. The larger question is whether the bank has the capital it needs to deal with borrowers who don’t pay up. Those losses hurt capital reserves.
“They’re selling performing loans, and that’s very good,” Balicka said. “On the other hand, they’re not able to handle their non-performing loans at all. Eventually [less aggressive write-downs] are going to catch up to them, but at this point they don’t have the capital to be more aggressive.”
The bank had to increase its allowance for loan losses – the money the bank is required to set aside to deal with potentially soured loans – to $269.4 million at the end of the third quarter, compared with $258 million the quarter before. Non-performing assets – the loans that aren’t paying on time, whose collateral values have declined or whose borrowers have cash-flow problems – grew from $348.3 million in the second quarter to $384.8 million in the third.
On a brighter note, Pacific Capital said about a fifth of those non-performing loans were still paying on time but had been marked because of declines in the value of the collateral underlying the loan or other issues that didn’t yet affect payments. The bank may get some relief from having to set aside money to deal with those loans. On Oct. 30, the FDIC issued guidelines saying that commercial real estate loans wouldn’t necessarily have to be called non-performing if the only problem was a decline in the market value of the real estate.
In 2010, the bank faces big questions about its refund anticipation loan programs. Those program give instant cash to taxpayers who expect to receive a return and require Pacific Capital to make thousands of extremely short-term loans in the first quarter of each year.
In the past, Pacific Capital would bundle those loans up and sell them off so the loans didn’t clog its books and require extra capital. But in early 2009, with a dead market for those bundled loans, the bank had to take $2 billion of them onto its balance sheet. That distorted its capital ratios and drew the attention of federal regulators.
The refund anticipation loan programs have generated much of the profit that Pacific Capital used to expand over the last decade. But with so little capital in its coffers and a still-chilled market for selling bundled loans, the question is whether Pacific Capital has room to run a refund program on the scale of years past.
Masterson was coy about the program during the conference call. “There are still a lot of moving parts,” Masterson said. “We’re still looking at the scale of next year’s program and the funding of next year’s program, both on balance sheet and off balance sheet.”
The fate of the program, and the profits it could generate, probably remains in the hands of regulators. And their view may be dim – the refund programs have drawn the ire of consumer advocates who say the promise of instant cash lures low-income taxpayers into paying exorbitant fees.
Balicka said a scaled-down program is possible, but she added: “The bank at this point doesn’t do anything without the regulators knowing and approving it.”