By Pacific Coast Business Times Staff Monday, August 10th, 2009

The next two quarters could be the most important in Santa Barbara-based Pacific Capital Bancorp’s history.

The parent of Santa Barbara Bank & Trust and four other banking franchises on the Central Coast, Pacific Capital said July 30 that it suffered a $362 million loss in the second quarter. That news followed 300 job cuts in March, a $7.9 million loss in the first quarter that surprised some analysts and an announcement in late June that the company would suspend some payments on federal bailout money that sent Pacific Capital’s stock tumbling 20 percent in a single day.

But much of the mushrooming loss in the second quarter involved a non-cash accounting measure to shrink the company’s assets and an aggressive move to brace for potential future losses rather than money actually going out the door. It comes after a first half of 2009 that reflects the bank’s efforts to adapt to a drastically different credit market and a changed economy.

In the first quarter, a frozen securitization market forced the bank to keep on its books loans that it normally would have bundled and sold, distorting its balance of capital to loans. And in the most recent quarter, it was aggressively laying back money to guard against potential losses on borrowers who are still paying on time but have seen the value of the real estate backing their loans fall or their revenue shrink.

“Clearly there’s been an element of conservatism in their approach to dealing with problem credits for a while,” said Aaron Deer, who is an analyst with investment bank Sandler O’Neill and Partners but is not involved in that company’s consulting work for Pacific Capital. “I would argue they’ve been more aggressive in writing off loans and more aggressive in building their reserve for loan losses.”

The next two quarters could tell whether the securitization markets unfreeze and whether Pacific Capital’s steps to brace itself have been enough.

Meantime, the bank wants more capital. In its July 30 earnings announcement, Pacific Capital said its tier one leverage ratio – basically, capital divided by loans – was 5.6 percent, still within federal guidelines but below the 8.5 percent the bank had voluntarily agreed to aim for.

The company announced a three-year plan to shore up its capital position that includes a mix of selling off loans, pulling back the bank’s balance sheet and cutting costs. But it has also retained an investment bank – Sandler O’Neill and Partners – to seek and evaluate all its options.

“The plan is designed to stretch our capital as far as we can. The plan we put together is only as good as our assumptions,” Chief Executive Officer George Leis said. “What we strive to do is measure optimism with reality.”

One thing analysts agree on is that despite its recent challenges, Pacific Capital is still a very valuable business.

“They’ve got a terrific branch network and some very good bankers working for them — it’s reflected in their clientele,” Deer said. “They’ve got a nice deposit mix with a good base of core deposits. On the lending side, they’ve got a good mix across loan categories that includes commercial as well as retail.”

Analysts don’t seem to think that selling a chunk of the bank or the part of its business that makes advance loans on income tax returns makes sense. Julianna Balicka, an analyst with Keefe, Bruyette & Woods, which isn’t doing business with Pacific Capital but makes a market in its stock, believes the best way for the bank to unlock its value is to merge with another bank.

“[Pacific Capital] is now most interested in making sure that their operations and the value they’ve built over time aren’t lost,” Balicka said. “I think one of the best ways for them to do that would be to merge with another bank. To raise enough capital right now, given their stock price, makes for a very difficult transaction and undervalues what’s there.”

A likely buyer might keep Pacific Capital largely intact, Balicka said.

“[Pacific Capital’s] community bank model is not broken. What’s broken is their capital model and their ability to get through their immediate credit headwinds,” Balicka said. “Their deposit business isn’t broken.”

But company leaders say their first effort will be to pull though without outside capital. To do that, they will sell $150 million in real estate-backed loans by the end of the year and squeeze $45 million to $55 million out of the bank’s expenses.

The bank also plans to get out of much of its residential home construction lending. Because of space restrictions, Leis said, the Central Coast is a “closed market” for home building, and Pacific Capital intends to pull back to reflect that.

“We’re exiting the residential construction area. That division is driving the losses, and I just don’t think it’s core to our business going forward,” Leis said. “We don’t have any business going to Reno or Bakersfield, those places with vast expanses of land.”

The bank’s commercial real estate business will also shrink, Leis said. “Even though it’s a very important asset in our market, we don’t want it to consume our balance sheet,” Leis said.

To save costs, Leis said, the bank will move toward standardizing a platform for its lending across the franchises it’s acquired. And though he said he reserves the right to close branches, as Pacific Capital has done in Santa Paula, Leis dismissed any notion that Pacific Capital’s footprint from San Diego to the southern tip of Silicon Valley would shrink dramatically.

“We are confident that all geographies can work,” Leis said. “We can be on fewer loan systems.”

Leis also said the bank intends to move to a more data-driven approach without abandoning its commitment to customer service.

“We need to do a better job modeling. We had a very intuitive, customer-driven approach,” Leis said. “We don’t ever want to screw that up, but we want to move to a more modeled approach.”

Balicka said the bank has been doing the right things but wonders if it will be enough to stave off a potential merger.

“Since [the addition of Chief Operating and Chief Financial Officer Stephen Masterson], one can see a sig improvement in how they reacted in credit problems,” Balicka said.

“Aggressive charging off can be traced to him having an impact. That’s good to see, but they ran out of time.”

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