Pacific Capital Bancorp: Evasive Maneuvers

So, in my last article I was completely right in predicting that Pacific Capital Bancorp (PCBC) would have a huge spike in delinquent loans in Q1, but the stock is not down much. What gives? Investors are ignoring the danger signs and evaluating the stock solely based on earnings estimates. In this case, earnings guidance is the sirens’ sweet singing luring your ship ever closer to the perilous rocks.

Non-performing loans grew by a staggering 113% in the 1st quarter, from $76.7 million in Q4-07 to $163.7 million in Q1-08. At the same time, the allowance coverage to non-performing loans dropped from 61% to 36%. What is the loss exposure on those delinquent loans? This question was on the minds of several analysts on the conference call. The majority of the non-performing loans are to homebuilders, so the analysts asked about the Loan to Values (LTVs) on the homebuilding loans.

The first analyst to ask the question was from FTN Midwest Research. He asked, “Have all --- has the entire homebuilder portfolio undergone updated appraisals in that whole process? And where do you see those LTVs today, if so?” Management answered about the updated appraisals but did not answer the LTV question. The analyst did not re-ask the question.

The second analyst to ask the question was from Fox-Pitt Kelton. He asked, “With respect to the builder portfolio and some of the updated appraisals, could you give us a sense of where the LTVs are coming in post appraisal for some of the loans that you moved to non-performing status this quarter?” PCBC’s CEO, George Leis, talked about the deterioration in pricing but did not mention the LTVs for these loans. The analyst did not re-ask the question.

Later in the Q & A, another analyst attempted and was finally able to nail them down. The analyst from Sinova Capital asked, “And then on credit, can you provide what your --- the most recent average LTV is on your builder portfolio, both the performing portfolio and the non-performing? " Dave Porter answered, “Yes, the range that we have is around 60-70%”

It sure did sound like Dave was trying to leave it at that! He did not specify performing or non-performing, it just sounded like the answer for both. But thankfully, our pit bull from Sinova Capital later nailed management down: “So then --- okay. So, based on your most recent appraisals, your performing loan construction portfolio has average LTV’s between 60% and 70%?” Porter: “Yes.” Sinova Capital Analyst: “Okay. And how about on the non-performers?” FINALLY admitting to the LTV on non-performing, Porter said: “Well again, obviously much higher on those. We’re looking at --- depending on the individual account, the LTVs could be as high as 100%.”

So let me get this straight: non-performing loans grew by 113% in one quarter and the loss provision coverage shrunk dramatically, and management finally admits that the delinquent home building borrowers have no equity left? LTVs at 100%? Wow! You would think that given the trend in delinquencies and no collateral left on the non-performing home builder loans, that management would at a minimum have greater than 100% loss provision to non-performing loan coverage. This all comes just after management stated on the Q4-07 conference call that: “We have current appraisals on most of the properties, and have applied significant discounts to the existing appraisals on the other properties for the purpose of determining our potential loss exposure. Based on this current analysis, we believe our exposure is relatively modest.” And also: “The remainder of our construction portfolio is performing well. Excluding the non-performing relationships that I just discussed.”

Given all of the management missteps and their evasive maneuvers on the conference call, you might think that PCBC is run by somebody with no banking experience (in case you missed my joke, check out Leis’s employment history).

Disclosure: Author has a short position in PCBC

Comments

[biomedlives]

I absolutely agree that the loan loss coverage is inadequate here. In addition, the returns on assets and equity for the core bank are poor.

[magistock]

Some reasons why the stock isn't down.

"The following table provides comparative asset quality data for the comparable three-month periods of the Core Bank (dollars in millions):

March 31, December 31,
2008 2007
--------- ------------

Allowance for loan losses $ 58.3 $44.8
Allowance for loan losses/total loans 1.06% 0.84%

Total non-performing assets $163.7 $76.7
Total non-performing assets/total assets 2.37% 1.04%

Allowance to non-performing loans 36% 61%

Net charge-offs $ 2.2 $ 1.4
Annualized net charge-offs/total average
loans 0.16% 0.10%

The Company's total risk weighted capital ratios as of March 31, 2008, and December 31, 2007, were 13.2% and 12.3%, respectively.

Outlook

Commenting on the outlook for Pacific Capital Bancorp, Leis said, "Based on the strength of our RAL and RT programs, we still expect our overall earnings per share to increase in 2008. However, due to the higher credit costs we are experiencing in 2008, we no longer expect earnings in the Core Bank to be higher than last year. Over the remainder of 2008, we expect our quarterly provisions for loan losses to remain elevated, although they should steadily trend lower as we move through the year. We expect that our positive trends in loan growth will continue to help us mitigate the impact of the higher credit costs."

Albeit, the numbers are not great. It isn't a disaster, considering how bad it is for other banks. The market is telling you to cover your short and move on to another bank that is being shorted more heavily and that you can try to manipulate with other shorts to make a profit when the news is bad.

[mgr1929]

One of the worst signs a CEO or CFO can give off is evasiveness. Share holders should review the conference call for themselves. All bank stock owners should be very wary of these types of stocks and switch to a more transparent and stable financial institution.There is no way the assets on the books of these banks should be valued at 100 cents on the dollar which is where most of their loans are valued.
mgr1929

[heynow]

Did you not notice that they happened to blow away the analyst estimates in Q1 because of all the money they made in the RAL program? Maybe that is why the stock has held up.

Did you not do any research on the RAL program before you put on your short position? Sounds to me like you didn't do enough homework on this one and now you are crying about it.

[Cruzer theBruiser]

Dude. Loan loss provisions are not dollar for dollar on collateralized loans. Provisioning 100% on real estate deals is re-cock-u-lous and a really bad use of balance sheet liquidity. The banking business is based on using leverage. You should know that. Hello?

PCBS should remain as under provisioned as it possibly can withstand for as long as it can and utilize those funds elsewhere. Excess provision is a leading cause of bank under-performance.

Specifically regarding PCBS's provisioning level(s): there exist determining variables that aren't apparent and cannot be made transparent until after they occur -- namely, work out scenarios, short collateral sales, note sales, guarantors stepping up to the plate, etc. Skilled banks are pretty good at looking 90 - 180 days down the road. That the provision hasn’t been increased proportionately to the rise in non accrual loans is an indicator ONLY that losses equivalent to those non accruals are not expected in the next 180 days.

Meanwhile, back at the ranch. The last time I looked, PCBS had $700 million in Tier I and Tier II capital on the balance sheet. I imagine they aren’t going anywhere any time soon, whether they earn $100 million in 2008 or only forty seven cents – maybe somewhere in the middle.

So, while you may be gaming short, PCBS's stock has declined at the same rate as 95% of the rest of the market. You haven't predicted much. Just so we are all very clear that you aren't an expert in bank balance sheet management, and that you have a financially vested interest in the stock's decline, all in all I would say that your comments are pretty much lack luster.

By the way… a 113% increase in non performing loans means what? They went from $76 million to $163 million in non performing assets? Yikes! That leaves $5,836,300,000 in performing loans. You need to look at peer banks and see what they are doing. Analysis requires objective comparison. PCBS’s overall loan portfolio has been well performing over time. As such, a doubling in non performing assets in the worst banking crises in 50 years is actually remarkable. Remarkably LOW.