PCBC Shareholders Ask ‘What Will Happen to this Train Wreck’

A lot of people are wondering what is about to happen to Pacific Capital.  Since the beginning of the year, PCBC has slowly, but steadily, marched downhill.   The shares entered 2009 at $17.  Today, they closed at $1.44.

The future is not clear, though.  PCBC may be acquired by another bank.  The FDIC might intervene.  It is hard to know, although the decline in the share price suggests that investors are dubious about the bank’s prospects.  Analysts have talked about selling off the refund anticipation loan (RALs) business.  That is an interesting question – and something that I would like to consider today.

As bad as things are right now, it could get worse.  For one, PCBC may lose some of its ability to shelter losses from its books.  According to analyst Julianna Balicka (Keefe Bruyette and Woods), Pacific Capital may have to absorb losses that were previously covered by a tax shelter. Those accounting changes, if put into play, would take effect on Thursday.

That would only fan the flames.  Yesterday, shareholders voted to increase outstanding shares five fold.  Effectively, it opens up the possibility that outstanding shares will increase more than tenfold, though.  Right now, only about 46.8 million shares are outstanding.  The BOD had authorization for 100 million shares, and as of yesterday evening, they have permission to issue as many as 500 million shares.  Do the math – a full issuance would translate into a new share value of thirteen cents.

Granted, the numbers are going to be different because the BOD also got permission to effect a 10-to-1 reverse stock split.  That won’t do anything to change the value of the company, or the huge loss in wealth that its existing shareholders could face.

Where do we go from Here

This is where it gets interesting.  PCBC is probably not going to stay a going concern for much longer.  Sure, there are message board-optimists like “kbanker2002,” but those folks are pretty lonely.

Let’s consider some potential outcomes:

• Takeover: a private buyer emerges and proceed to buy up a majority position in the low-priced shares of PCBC.  This seems very plausible given that the BOD has already retained Sandler O’Neill to work out “strategic alternatives.”
• FDIC receivership: again, also a possibility.  PCBC’s tier one capital ratio was just 5.7 last quarter.  It needs to get a lot better, and soon.  New equity would help that, but will it be enough? Will the new accounting hinder the chance of a return to adequate capitalization?

Shareholders aren’t going to be happy with either scenario.  The former might be slightly better – shareholders might get a little compensation.  With the latter, they will get nothing.  No soup for you!

The disposition of the RAL portfolio within a new ownership structure seems particularly “in play.”  RAL lending is hardly a household line of business.  In fact, only about four other financial institutions in the country compete with PCBC: JP Morgan Chase, Republic, HSBC, and River City.  HSBC plans to get out.  River City is a bit player.  Republic already faces some regulatory push-back from the FDIC.  The FDIC issued a cease-and-desist order against Republic this spring.  Chase could buy PCBC to consolidate its hold on the market.  However, it is hard to imagine that PCBC or its eventual owner would get much of a price for the RAL business if there is only one bidder.

The RAL portfolio is an ugly duckling.  No one knows if the loans will perform better in the future, but the last few years have been dreadful.  RALs constituted 82 percent of the loan losses for PCBC in 2007.  Net loan losses on RALs were $92 million in 2007 and $36.7 million in 2006.  They are high interest loans, but they are very risky. This year, to make it worse, the freeze-up in the securitization markets meant that Pacific Capital had to hold on to more of its RAL portfolio.  Since most, if not all, of those loans are made in the spring, it can create a liquidity challenge.

FDIC ownership would not mix with RAL lending.  It is evident, from the actions taken by the FDIC against Republic, that the regulators there have some bad feelings for this business.  Moreover, why would the government want to maintain a business that only serves to siphon off funds from other endeavors.  Remember that almost all RAL clients get the Earned Income Tax Credit.  The RALs take a share of those refunds, which are largely driven by refundable credits from the EITC.

That means tax filing firms are likely to have one less source of liquidity for their tax refund businesses next spring.  This is good news for consumers.  People might demonstrate that they want tax refunds, but that doesn’t mean that they should have those refunds.  The RAL product saps wealth from people who can’t wait long enough to get their refund from the IRS.