The Twilight of RALs at Pacific Capital

Yesterday’s earnings report at Pacific Capital was, at best, a mixed bag.  Pacific Capital lost 87 cents per share.  They were expected to lose 80 cents per share, but then again, last quarter they lost $7.77 per share, so maybe it is a vast improvement.

CEO George Leis was optimistic about their quarter.

“The aggressive approach we took earlier in 2009 towards resolving our problem loans helped drive a substantial decline in our credit costs, particularly in the construction and land portfolio, said Leis in a prepared release.  “While our credit costs still remain elevated above historical levels, we are encouraged by the moderation we experienced in the third quarter.”

Gee, that’s swell.  Lose $41 million, call it encouraging.

This earnings report should concern shareholders not just at Pacific Capital, but also franchise owners and shareholders at their RAL partners, Jackson Hewitt and Liberty Tax Service.

Unusual Accounting

The problem for PCBC is that they don’t have much more room for more losses.  Shareholder equity is now just $397 million. Non-performing assets reached $384 million. That’s a rosy scenario, too: non-performing assets should probably be $400 million.  Either way, non-performing assets are just about even with  equity.  The false optimism is evident elsewhere: in spite of what we are hearing about the state of commercial real estate in California, they have set aside a provision of only $47 million for expected loan losses in Core Bank.

Going forward, it is realistic to say that Pacific Capital is now at a point where their shaky finances are going to curb their ability to continue to operate in some of their more risky product segments.

One of the odd things about their latest 10-k is how it counts performing loans.  There is a line on their balance sheet for loans that are past due but accruing interest.  Those loans are counted as “performing,” even though the borrowers are not making payments.  PCBC elects to call them performing only because their bookkeepers are still adding interest to principal.  These loans, which probably shouldn’t be separate, are being counted as solid assets.

Looking Forward

The upshot is that PCBC may not be able to continue its refund anticipation loans business next quarter. The RAL business has always been somewhat risky. Fraud is high on these loans, the underwriting is outsourced to the IRS, and they put strains on liquidity. Last year, the IRS’ debt indicator had some trouble. To the extent that the debt indicator does underwriting on RALs, the results were very poor.

The first big problem is that the market to securitize RAL loans has dried up.  Pacific Capital kept most of its RALs on the books last year because they couldn’t sell them, as they have done in previous years.  That is hard for liquidity, at a time when PCBC needs liquidity.  RAL loans are extremely short term by nature – usually less than two weeks – but the lender must put out cash nonetheless. PCBC is worried about liquidity even now.  Their net interest margin slipped 78 basis points this quarter.  The report says that they pursued “investments in low-yielding assets that provide greater liquidity.”  Most RAL loans are made in a very narrow window of time – usually in the first two months of the years.  Borrowers who uses RALs are impatient to get their refunds.  They get a RAL because they can’t wait to get their return.  They file early because they can’t wait to get their return.

Regulatory capital ratios are low – Tier One Leverage is just 5.6 percent and Tier One Capital is 7.9 percent.  The FDIC wants Tier One Capital up to 9 percent.  Rather, they wanted it up to 9 percent by the end of September.  That didn’t happen, and now the ball is in Sheila Bair’s court to see if she follows up with her statements. There could be a cease-and-desist order coming on RALs, given their consumption of cash and their historically high rate of losses.  RALs are one place, the only place in fact, where PCBC has been making money.  Without RALs, the lights are just one step closer to going out.

My perspective

Just a note – but I am an advocate who doesn’t like what refund anticipation loans do to my community.  They are very popular in North Carolina.  It is especially so among low-income residents.  More than 80 percent of our households that received a RAL also got the Earned Income Tax Credit (EITC).

Any taxpayer should be upset about the linkage between a TARP recipient and the Earned Income Tax Credit. Think about that – the federal government is giving TARP funds to a bank so that it can fund loans that extract money from a anti-poverty program of the federal government.  Take our money, so that you can keep on taking our money, it seems to say.  Oh, and now that bank isn’t even ready to make the dividend payments on those TARP funds!

If I am a tax partner of PCBC, I am looking for a new partner.  Right now, before tax season starts! If Jackson Hewitt suddenly hears from PCBC that they can’t fund those RALs, then its a major problem for Jackson Hewitt. Same with Liberty Tax Service, or with the scores of independent tax preparers who have relied upon Santa Barbara Bank and Trust for their RAL funding.