Pacific Capital Buys RALs, Can’t Pay its TARP Dividends

Pacific Capital Bancorp reminds me of that difficult family member that keeps on finding new ways to create problems.

This week, the news is that Pacific Capital is one of three banks that has announced that it will not be able to make its TARP dividend payment to the Treasury Department. Pacific Capital (PCBC) received $180.6 million last fall. It is a bad sign about the financial health of a bank that routinely pushes bad financial products on poor consumers.

For a refresher about PCBC, read this here.  The summary of the facts are that PCBC, located in posh Santa Barbara, California, is unable to turn a profit through traditional branch banking.  The bank makes loans on small businesses and home mortgages.  Even in Santa Barbara, though, they aren’t able to find a way to make that work profitable.

Instead, PCBC makes its profits by capitalizing the refund anticipation loan (RAL) business.  It partners with main street RAL providers like Jackson Hewitt.

A RAL is an unusual product.  If you haven’t heard of it, its probably reflects well about your financial habits.  Nonetheless, millions of Americans use this product during tax season.  A RAL is an advance on a tax refund.  Typically, a tax preparer will offer to give a tax filer their tax refund within one day of filing by using the RAL service.  The next quickest alternative is to e-file, but that can mean a wait of as long as two weeks. For that convenience, tax preparers impose a range of fees: there is a loan fee.  Consumers without bank accounts often pay to create a short-term deposit account.  Often, the deposits are transferred to a prepaid VISA card.  Even worse, the tax prep service can even charge a fee to check the balance or to make a withdrawal on that card.

This year, Treasury gave PCBC capital to help it through the credit crunch.  That turns out to have been necessary, because PCBC is running itself into the ground with unsound lending.  Its the kind of unsound lending that worked with our asset backed securities markets had a big appetite for high-risk debt.

That was then.  This is now: PCBC was not able to sell the pools of refund anticipation loans that it now holds on its accounts.  In its most recent 10-Q, PCBC indicated that it was holding average RAL assets of $2.3 billion.

RALs are risky assets.  PCBC set aside $155 million against loan losses on the RAL product (s).  The losses are a product of the opacity of these advances.  Although the federal government attempts to spot any outstanding tax liabilities held by a filer, there can still be problems.

Don’t worry, Uncle Same will get its money.  Recipients can defer up to six dividend payments. That said, deferring a dividend payment is a very worrisome sign.  The market continues to hold PCBC’s shares in a poor light – since their TARP infusion, in fact, shares have dropped to just a third of their value.  Today, the shares are trading at just $3.18.

Maybe what is most maddening about this situation (which gets more maddening all of the time!) is that the RAL program is dependent upon other government aid.  Most tax refunds for RALs are dependent upon the Earned Income Tax Credit.  The EITC is a succesful anti-poverty program that provides refundable tax credits to low-income families with wage income.  In other words, it eliminates the disincentive that is common in some relief schemes.  The EITC rewards work.  Unfortunately, RALs allow private banks to siphon off the EITC.

This is a unforeseen situation.  And it is getting worse.  Before, private companies were taking public money away from the intended recipients in order to fuel their own profits.  Now, private companies are being funded by the government to take funds away from other recipients of public money.

Oh, and now, those private banks are proving unable to pay back the money that the federal government has given them in the first place!  Just dandy.