By Pacific Coast Business Times Staff Monday, January 25th, 2010

With Pacific Capital Bancorp’s earnings call slated for Jan. 28, investors and analysts will be looking for clarity and answers now that the bank’s most likely fate is a merger. Failing that or a big infusion of capital, a regulatory seizure looms on the horizon.

On Jan. 14, Pacific Capital, the parent of Santa Barbara Bank & Trust and several other Central Coast banking brands, sold off a major source of profits, its refund anticipation loan division, a controversial program that provided fast cash for expected tax returns, often to low-income taxpayers. It received only $10 million for the program, a stunningly low price that will do little to alleviate the bank’s capital needs.

Meanwhile, the bank has paid off pension obligations, reduced retiree benefits and once again trimmed staff.

Last spring, Pacific Capital agreed with regulators to get its tier one capital ratio — its ratio of free capital to loans and other assets — up to 8.5 percent by June 30 and 9 percent by Sept. 30. It missed the mark both times and came in with a ratio of 5.6 percent at Sept. 30.

Though the deal was voluntary, neither the bank nor regulators have said what happens next. Analysts want to know.

“I would imagine after two quarters, the capital guidelines are going to become a little less optional,” said Julianna Balicka, an analyst with Keefe, Bruyette & Woods.

Using figures for the bank’s third quarter, when it lost $40.7 million, Balicka estimates the firm needs to raise at least $75 million to meet regulators’ demands.

“Even if they raised that $75 million, I don’t think the market is going to think that’s enough,” Balicka said. “[Pacific Capital’s] best option may very well be to bail.”

Tapping the markets to meet its capital needs seems an increasingly unlikely outcome for the bank. The firm’s market capitalization — the value of all of its outstanding shares on the market — is around $60 million, meaning existing investors would suffer a massive dilution in a big capital raise. And Stephen Masterson, Pacific Capital’s chief financial officer, is slated to leave in early March, with no replacement announced.

“It’s going to be very difficult for any bank to raise capital without a full management team,” Balicka said.

Shares have traded around the $1 to $1.25 mark for months, down sharply from the $20 or more they fetched as recently as a year and a half ago. That means the best options for investors might be a buyout, especially one in which they’re compensated with stock in a stronger bank with good growth prospects.

Aside from regulatory concerns, analysts will be looking at Pacific Capital’s deposit base — which has held mostly steady during the bank’s crisis — and potential for loan growth. The bank’s refund anticipation loan program, which generated hundreds of millions of dollars in profits over the past decade, concealed the fact that Pacific Capital’s core operations weren’t very efficient or profitable compared to similar banks.

“The [refund anticipation loan] business is now gone,” Balicka said. “Can they have loan growth whatsoever? Deposits are one thing, but there’s the whole other side of the balance sheet that brings in the revenue.”

The sale of the refund anticipation loan program has been a sticking point for investors. In early 2009, Pacific Capital ran into massive trouble finding funding to originate the billions of dollars in short-term loans the program requires. Once regulators cracked down on the bank’s capital levels, it became clear to many observers that regulators were unlikely to let the bank stretch itself thin to carry out the program in 2010. On Christmas Eve day, Pacific Capital said regulators wouldn’t let it go forward with the program and that it was for sale.

The final price spurred observers to wonder whether the program could have been sold off more profitably earlier. Pacific Capital has faced criticism for not facing reality sooner rather than later, some of it from investors who filed lawsuits against the firm alleging that its leadership hid burgeoning loan losses from the public.

“Perhaps the company will open up and tell us why the price [for the refund anticipation loan program] was only $10 million,” Balicka said. “I’d like to think that the bank management will be more forward-looking than I’ve observed in the past.”

Since 2000, Pacific Capital has earned about $303 million from the refund loan programs after taxes, Balicka estimates. Without it, the bank would have been at a net loss for the past decade, when it made an overall after-tax profit of only $205 million, Balicka said.

“This makes the sale [of the rest of Pacific Capital] a lot more acute because they really didn’t alleviate their capital needs,” Balicka said. “$10 million is a drop in the bucket.”

Meanwhile, the bank also said Jan. 14 that it would end its deferred compensation plans for its top executives. Those programs allowed the executives to be given part of their pay at a later date to avoid some taxes while saving for retirement. At least two top-level executives will be getting lump sums right now instead. Clay Larson, vice chairman of the board of directors, will get $818,588 in cash and stock, and Frederick Clough, the company’s executive vice president and general counsel, will get $24,465 in cash and stock.

Pacific Capital has also clamped down on retiree health care benefits. Debbie Whiteley, executive vice president of investor relations and corporate communications at Pacific Capital, said the bank has changed its benefit plan to pay 50 percent of the costs for eligible retirees and their spouses until those people become eligible for Medicare. After that the subsidy will cease, Whiteley said.

The cuts come as retirees and other owners of Pacific Capital’s stock are reeling. Dividend payments have stopped, a move the bank was forced to make when it suspended payments on the $181 million in federal bailout money the bank received.

Whiteley said the affected retirees received a FedEx package with documents about the changes — “this was the only way to ensure that they received all of the materials on the changes,” Whiteley wrote in an e-mail — and that the bank has set up a hotline to handle questions.

“Given the current operating environment, we have been in the process of evaluating all of our operations expenses to identify areas where costs may be out of alignment with prudent management of the company,” Whiteley wrote in an e-mail statement. “Our evaluation of our benefits plans clearly identified that [Pacific Capital’s] practices with regards to health plan coverage for retirees have historically been substantially generous and above the industry norm.”

Finally, Whiteley said the bank has made 15 more layoffs early this year in addition to the roughly 300 Pacific Capital announced as a cost-cutting measure in 2009.

“As we’ve indicated all along we’re going to continue to look at places where we can trim expenses,” Whiteley said. “While it was a difficult thing to do, it’s important. There could be more throughout the year.”

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