Time to say goodbye

The demise of Pacific Capital Bancorp

The collapsing stock price of Pacific Capital Bancorp (nasdaq: PCBC) has prompted several people to ask if I think the bank is going to fail. While I don't usually forecast stock prices (in fact, a big part of my job is teaching my clients to ignore such things), PCBC's demise is pretty much a foregone conclusion. To me it is not a matter of if the Feds step in, but when. We have seen 120 other banks shuttered so far in 2009. PCBC will probably make it 121.

This is hardly a heroic forecast. With the stock now trading well below $1.00 per share, the stock market seems to share my dismal view. 

In the spirit of full disclosure, we eliminated any exposure to Pacific Capital Bancorp in any of the accounts we manage a long time ago. I consider myself a neutral observer. In that role, I read PCBC's third quarter earnings release and listened to the third quarter earnings call with George Leis (President & CEO), Stephen Masterson (CFO) and David Porter (Chief Credit Officer). I hoped to learn something encouraging. Unfortunately, I came across nothing to change my opinion. Without going into the technical details, here are the key points I took away from the call:

  1. The bank is doing everything it can to build liquidity. Some of their major efforts in the third quarter included a full court press to increase deposits by $279 million; tapping FHLB advances for another $177 million; and selling $86 million of their best quality commercial real estate loans. These funds were mostly invested in very liquid, short-term securities.
  2. PCBC is well-capitalized, but below the levels they are required to maintain by the Office of the Comptroller of the Currency (OCC). We don't know if the OCC is growing impatient with the bank's failure to boost capital. Management insisted on not discussing anything related to their talks with regulators.
  3. Asset quality continues to erode, though at a slower rate. Non-performing loans are now 5.14% of total assets (compared to 5% in the 2nd quarter) and delinquent loans make up 8.6% of total average loans in the quarter (compared to 7.76% in the 2nd quarter.)
  4. Profitability is poor and will likely remain poor for the foreseeable future. Net interest margin (the difference between what a bank earns on its assets and pays on its deposits) is the lifeblood of most banks. Unfortunately, for PCBC net interest margin is getting squeezed by their efforts to build liquidity and Stephen Masterson was very clear this effort will continue through 2010. In addition, non-interest expense is growing while non-interest income is contracting.

Looking at these factors, I have a hard time finding anything to feel genuinely optimistic about. Management says they are continuing to explore their "strategic options" (which usually means selling all or part of the company), but so far the only strategic vision I hear from management sounds like "don't worry, be happy."

In order to check my impressions against a second trustworthy source, I looked at an analysis prepared by the folks at Bankrate.com.  If you aren't familiar with them, Bankrate.com is a well-respected resource for information about banks and the banking industry. Their analysis corroborates my view. I encourage you to take a look at it.

Personally, I'm not that saddened by the loss of PCBC, per se. I never liked their heavy dependence on Refund Anticipation Loans. I was also frustrated by the nagging systems problems that they never seemed to fully solve--a problem that stemmed from trying to integrate so many community banks onto a single technology platform.

On the other hand, I am very disappointed to see fine institutions like First National Bank of Central California, San Benito Bank and South Valley National Bank--banks that started with such promise and did so much good for our communities--wind up so beggarly. It is too simple to say that the problems were all the fault of the folks in Santa Barbara (Pacific Capital Bank's headquarters.) But it isn't too far-fetched to believe that these banks might have done better if management had stayed closer to home.

Where do we go from here?

As I mentioned earlier, I believe it is only a matter of time before the FDIC steps in to protect depositors. They will likely follow one of two paths. 1) They will transfer the deposits to another institution and sell the assets, thereby effectively wiping out shareholders; or 2) They will facilitate the sale of the bank by insuring the assets, thereby effectively wiping out shareholders.  In either case, the depositors will be fine, but the equity will be worthless. How certain am I about this? Maybe 80 percent. There is always a chance PCBC will rise from its deathbed, but foreseeing that kind of miracle is beyond the scope of my craft.