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Pacific Capital Bancorp (NASDAQ:PCBC)

Q1 2008 Earnings Call

April 29, 2008; 9:30 am EDT

Executives

Tony Rossi - Financial Relations Board

George S. Leis – President and Chief Executive Officer

Stephen V. Masterson – Chief Financial Officer

David Porter – Chief Credit Officer

Donald Lafler – Former Chief Financial Officer

Analysts

Brett Rabatin – FTN Midwest

Andrea Jao - Lehman Brothers

Aaron Deer - Sandler O'Neill & Partners L.P

Joe Morford - RBC Capital Markets

Brent Christ - Fox-Pitt Kelton

Julianna Balicka - Keefe, Bruyette & Woods

Rajiv patel - Sinova Capital

Todd Binet with - Sage Partners

Trevor Morris - UBS

Operator

Good morning ladies and gentlemen, thank you for standing by and welcome to the Pacific Capital Bancorp First Quarter 2008 Conference Call. During today’s presentation all parties will be in a listen-only mode. Following the presentation the conference will be open for questions (Operator Instructions). This conference is being recorded today Tuesday April 29th of 2008. Now I would like to turn the conference over to Mr. Tony Rossi, of the Financial Relations Board, please go ahead sir.

Tony Rossi

Thank you operator. Good morning everyone and thank you for joining us to discuss first quarter results with the management of Pacific Capital Bancorp. With us today from management are George Leis, President and Chief Executive Officer; Stephen Masterson, Chief Financial Officer; Dave Porter, Chief Credit Officer; and Don Lafler, the company’s former Chief Financial Officer and now a consultant to the Finance Department. Management will provide a brief summary of the results and then open up the call to questions.

During the course of the conference call, management may make forward-looking statements with respect to the financial conditions, results of operations and the business of Pacific Capital Bancorp. These include statements are relate to or are dependent upon estimates of assumptions relating to the prospects of continued loan and deposit growth, improved credit quality, the health of the capital markets, the company’s de novo branching and acquisition efforts, the operating characteristics of the company’s income tax refund program, and economic conditions within its markets.

These forward-looking involve certain risks and uncertainties many of which are beyond the Company’s control. Forward-looking statements speak only as of the date they are made and Pacific Capital Bancorp does not undertake any obligation to update forward-looking statements to reflect circumstances or events that occur after the date of forward-looking statements are made. At this time I would now like to turn the call over to George Leis, George?

George Leis

Thank you, Tony. Good morning and thank you for joining us this morning. I’m going to provide a brief overview of the first quarter of 2008 and then I will turn the call over to Stephen Masterson our new Chief Financial Officer who reviews our financial results in more detail. Following Stephen’s remarks, I’ll conclude with the discussion of the outlook of the remainder of 2008. We generated $1.56 in earnings per share in the first quarter of 2008, a 43% increased and the $1.09 we earned first quarter of last year. Our strong performance was driven by substantial improvement in our refund anticipation loan and refund transfer programs this year.

As you may recall following the higher than usual loss rates experienced the RAL program last year, we said on prior calls that we would be making a number of changes to our RAL program. We’ve included significant enhancements in our risk management controls. Including discontinuing certain higher risk products and improving our fraud screening processes. As we expected these enhancements substantially reduced our loss rate without having a significant impact on our volumes.

Our loss rates for the 2008 programs is tracking at about 1% of the total RAL’s originated this year, compared with almost 2% last year. In March 31st we still had about $61 million in RALS’s on our balance sheet inline with our expectations and about $36 million lower than the same point last year. All RAL’s that were originated prior to March 1st, 2008 have already have been paid off or charged off. Subsequent to the end of the quarter we have continue to collect on these loans consistent with our expectations. At the present time we have about $10 million outstanding from the March 31st balance and we have an allowance of $7.5 million against these loans.

In discussing our RAL and RT season it’s important to note that all numbers reflect where we were as of March 31st and there is a small amount of additional activities in these programs that occur in the second quarter. On total transaction volumes both RAL and RT’s increased by 27% this year. The primary driver of this strong growth was an approximately 15% increase in a number of tax preparation offices that offer our RAL and RT’s to their customers.

In addition to the new office that we signed up during the past year. We also benefited from a number of independent tax prepares significantly growing their businesses this year, which resulted in more RAL and RT transaction opportunities for our bank. As a result we saw 58% increase in total volumes through the independent tax prepared channel. As of March 31st, the products mix with 73% RT’s and 27% RAL compared to 69% RT’s and 31% RAL within 2007 season. The increase in RT’s is attributable to higher volumes through the interior channel this year which is entirely RT’s as well as the tighter underwriting criteria for our RAL.

When a RAL application is denied, then automatically converts into an RT, which presents no credit risk to the bank. Like RAL and RT also provides for the upfront payment of the customer tax preparation fee. We were very pleased with the execution of the program this year. Everyone on RT who is involved in the program performed exceptionally well on the key responsibilities such as implementing our new risk management procedures, lining up our funding sources, attracting new tax preparation offices into our programs and efficiently processing all of the transaction request.

As we indicated one of our highest priority entering 2008 was to restore our RAL and RT programs to their prior levels of profitability and we are very pleased to have succeed in this effort. Moving to the Core Bank, we saw a positive trend in loan growth and net interest margins during the first quarter. However, we experienced significant deterioration in our home construction portfolio. During the first quarter specific markets in California experienced dramatic and unprecedented declines in housing prices. In some areas within the Central Valley of California and Reno, Nevada housing prices declines by as much as 50% to 70% in just three months. While our one-to-four residential real estate portfolios are not located in areas that have seen this kind of drop, homebuilders in the impacted areas have been affected.

We have made some loans to long term home building customers who have projects in these areas, because many of our local central coast markets are built out and our customers have found it necessary to move outside of their traditional markets. During the first quarter our Internal Loan Review Department engaged in external review firm to assist us in conducting a throw denomination of our home building portfolio using current appraisal data.

As a result of this review we downgraded approximately $79 million of loans to customers in the homebuilding industry to non-performing status. These loans accounted for 91% of increase in non-performing assets during the first quarter. Accordingly we determined that we needed to increase our allowance to this portfolio which was resulted in a provision for loan loss in the quarter of $15.6 million. We are working closely with our borrowers and have remediation plans in place to help minimize charge offs that may need to be taken in the future.

For the remainder of the 2008 we believed that our quarterly provision for loan losses will higher than our initial expectations although they should steadily trend lower as we moved through the year. We don’t believe that we have seen the bottom with respect to the housing market in California and our updated provision assumptions reflects some degree of continued deterioration. We do however believed that another period of precipitous drops in market values like we saw in the first quarter is highly unlikely. So, we feel confident stating that our provision expense will trend lower going forward.

Before I conclude I wanted to efficiently welcome Stephen Masterson our new CFO. Stephen has more than 16 years of experience in public accounting with his primary focus on financial services companies. Before joining Pacific Capital he was Partner-in-Charge of Grant Thornton's Woodland Hills office servicing the greater Los Angeles area. Stephen is a great fit at Pacific Capital, he has served on the external auditing for our company for a number of years when he was with Arthur Andersen and he is very familiar with unique aspects of our business. He is already hit the ground running and look forward to him being a key part of our management team for many years to come. Stephen?

Stephen Masterson

Thank you George. Let me say that I am very pleased to be at Pacific Capital and I am looking forward to getting to know our shareholders and analyst in the days and weeks to come. Now on to the results of the first quarter, George already covered the RAL and RT programs so I will focus my comments on the performance of the Core Bank. The Core Bank’s net interest margin increased to 3.64% during the first quarter of 2008 from 3.62% in the fourth quarter of 2007. Despite the steep reductions and interest rates federal reserves we were able to improve our net interest margin to a disciplined approach to loan pricing and effective efforts to control funding cost.

Our non interest income excluding gains from securities sales totaled $15.7 million in the first quarter of 2008 compared to $16.8 million last year. The decline was due to a reduction and evaluation of mortgage servicing assets due to decreasing interest rates and the write off of a building and leasehold improvements. There were partially offset by an increasing in wealth management fee primarily due to the acquisition of R.E. Wacker & Associates the registered investment advisor we purchased in January of 2008.

The operating efficiency ratio for the Core Bank was 71.3% compared to 61.6% last quarter which excluded the impact of the non-routine actions that were taking in the fourth quarter of last year. The increase in the operating efficiency ratio from the fourth quarter of 2007 is primarily attributable to three factors that drove higher operating expenses. First we had a $2.6 million increase to our liability for credit commitments provided to customers in the construction industry. There was also a change in the methodology for calculating this reserve that let to the increase during the quarter. I should note that additions to liabilities for credit commitments are recognized as an operating expense rather than as a provision expense.

Second we had a $642,000 charge related to a lease termination for vacating a portion of an administrative building and third we had an increase in salaries and benefits expense during the period. This was primarily due to higher accruals were incentive compensation this quarter and payroll taxes which kicking at beginning of each year. There were no incentive accruals made last quarter as annual incentive compensation was reduced to reflect the financial performance of the company. There were also some strategic investment in the expansion of wealth management business that contributed to the increase this quarter.

The tax rate utilized this quarter can be confusing so I would like to explain how it is calculated. As required by GAAP, the consolidated tax expenses is computed using the company’s projected tax rate for the entire year applied to the quarter’s pre-tax income. The consolidated tax rate used in the first quarter is 37.65%. However, allocating tax expense between the Core Bank and RAL and RT programs present a challenge for two reasons. All of the tax exempts muni interest and other tax advantaged items relate to the Core Bank and the income from the RAL and RT programs is highly concentrated in the first quarter.

With no tax advantage income it is assumed that the RAL and RT programs should be taxed as the combined statutory rate of 42.05%. However, in the first quarter because of the extremely high proportion of fully taxable income, if the remaining tax expense is charged to the Core Bank then the effective rate for the Core Bank would be unrealistically low if not negative. Therefore the income statement in the press release reports, income only down to pretax income. If one were to compute a standalone or normalized tax rate for the Core Bank it would be 31.69%. If you have any questions about the application of the tax rate I would happy to address them and discuss them later in this call.

Turning to our balance sheet, total loans in the Core Bank were $5.5 billion at March 31, 2008 which represent and annualized growth of 10% from December 31st 2007. The growth primarily came within our non-residential construction commercial and multi-family real estate portfolios. Within the construction portfolio almost all of the new originations during the quarter were for commercial purposes and projects. Total deposits in the Core Bank were $4.6 billion at March 31, 2008 compared to $4.7 billion at December 31, 2007 and $4.8 billion at March 31, 2007.

The provision for loan losses in the Core Bank was $15.6 million in the first quarter. As George mentioned previously this higher provision reflects the deterioration we saw among our homebuilding customers during the first quarter. At March 31st, our total non-performing assets were $153.7 million compared with $76.7 million at December 31, 2007. As a percentage of total assets our non-performing assets were 237 basis points at March 31st compared to a 104 basis points at December 31st, 2007. Again this increase was primarily driven by the downgrading of the loans to customers and the home building industry.

While there is growth speculation within the investment community that commercial real estate will be next asset class to show deterioration, the data we’re seeing within our marketplace leads us to believe that our commercial real estate portfolio remains in good health. Occupancy rates in Santa Barbara area are very strong at 97% for office and 99% of industrial and retail. This is lead to increasing rental rates and constant cap rates in Santa Barbara. Commercial real estate also remains stable in the rest of our foot print and we see no negative trend in the portfolio. Our ratio of allowance to non-performing loans was 36% at March 31, 2008 compared to 61% at December 31, 2007.

When evaluating our allowance ratio coverage it is important to keep in mind that all of the major loans classified as non-performing are regarded as impaired for FAS 114 purposes. As such we had obtained current appraisal data and individually computed the amount of allowance needed to cover the loss exposure for each of these loans. In addition our residential construction loans are typically under written with a loan to value ratio between 60% and 70%. This conservative underwriting criteria provides a greater ability to sustained the clines in the value of the underlying collateral. Even though a large amount of homebuilding loans have been moved into the non-performing category the inherent loss in the credits remains relatively limited because of the low initial loan to value ratio. This dynamic will result in a lower allowance coverage ratio than in other scenarios where non-performing assets might have greater inherent loss.

Looking a head to the -- net charge offs, looking ahead, net charges offs of the Core Bank were 2.2 million in the first quarter. On an annualized basis this represents a 16 basis points of total averaged loans compared with 10 basis points for the fourth quarter of 2007. Now I will turn the call back over to George.

George Leis

Thank you Stephen. Looking ahead to the remainder of 2008, we continue to expect that our overall earnings per share will increase this year compared to last year based on the strength of our RAL and RT programs. However, due to the higher credit cost that we now expect this year we no longer anticipate that earnings in the Core Bank will be higher than last year. We see good opportunity to continue to grow in more stable areas of our loan portfolio particularly the C&I, commercial real estate -- commercial construction portfolio.

With the conduit market diminishing due the macro issues in the credit markets we are seeing more commercial real estate lending opportunities in fewer payoffs that we’ve seen in the past few years. We will also be aggressive in our efforts to further build outs our wealth management franchise this year and continue to grow this income stream. Our growth in these areas should help mitigate the impact of the higher credit cost that we’re experiencing. We would now be happy to address any questions you might have. Stephen and I are joined on the call today by David Porter, our Chief Credit Officer and Don Lafler our former CFO and now a consultant to the Finance Department. Operator we are ready for the first question.

Question and Answer Session

Operator

(Operator Instructions) Your first question comes from Brett Rabatin with FRN Midwest. Please go ahead.

Brett Rabatin – FTN Midwest

Wanted to -- first get an update on the homebuilder portfolio. How much is related to residential out of the 700 or so in total loans. How much in land and then if you guess geographically go through where you have exposure?

David Porter

Hi Brett this is David Porter. Approximately 45% of our total construction portfolio is related to residential construction. Of that amount with regard to land I am going to say that 25% -- lets see maybe 20% of the residential portfolio would be land itself and keep in mind that many of these projects include both lot development and housing construction at the same time.

Brett Rabatin – FTN Midwest

So that, I’m sorry to disinterest you though the land include lot development as well?

David Porter

No, the land would be more just the land itself, but typical in Homebuilding we’ll have developed lots as well as construction on houses going on, within a single project. With regard to geographic distribution I think, I indicated last quarter that we had about a 130 million of the Homebuilding portfolio outside our footprint in the Central California and Reno, Nevada area and that’s still a -- I think that’s still a good number to use

Brett Rabatin – FTN Midwest

So, that number hasn’t really changed much?

David Porter

It hasn’t no.

Brett Rabatin – FTN Midwest

Okay. Its says 130 million is the 79 million that you downgraded in the quarter, is that a reflection entirely of the 130 million outside of the footprint, or can you give us some color on where the downgraded loans came from and how many -- how many that represents?

David Porter

Sure, that’s a good question, Brett. Actually, as we indicated last quarter there was a large homebuilder in the Central Valley that was downgraded that represented about $33 million of non-accrual loans. This quarter we have three large relationships. The total approximately $60 million of that went to non-accrual status, one of those for about 23 million is in the Central Valley, the other two which totaled about $35 million are actually within the footprint. So the total of those five projects represents about a $105 million of our total non-performing assets.

Brett Rabatin – FTN Midwest

Okay. I’m sorry. Dave, can you I didn’t quite keep up there. You had one 20 million if I understood correctly, in the Central Valley; three large relationships were 60 million…

David Porter

In the first quarter.

Brett Rabatin – FTN Midwest

In the fist quarter correct and how much that was in, are internal or wherever accounting?

David Porter

Yes, in our footprint we had about $35 million of that $60 million went non-accrual.

Brett Rabatin – FTN Midwest

Okay. And you indicted in your commentary earlier that your low LTV’s should provide you minimal write-downs and so the reserve looks low on a NPA basis. Have all -- has the entire homebuilder portfolio undergone an updated appraisals in that whole process and where do you see those LTV’s today, if it so?

David Porter

Yes, we’ve actually been very aggressive in getting current appraisals particularly in this portfolio, Brett and on the five accounts that I have talked about we do have current appraisals on them. Through the quarter we’ve ordered many appraisals on the rest of the portfolio. Most of those that have come in were still waiting for some others to come in, keeping in mind that the appraisal process these days has been extended a little bit because of the heavy activity in ordering appraisals by a lot of banks.

Brett Rabatin – FTN Midwest

Okay. Maybe [Inaudible] off-line about credit. Just one last question and will jump off, I wanted to -- I don’t know if you want to give a number, but I was curious how much liberty added to the other professional tax preparer line in terms of year-over-year growth of about $1.1 in transactions?

David Porter

I’m not -- Don do you have that number?

Donald Lafler

Yes this is -- they added approximately 500,000 transactions to the 250,000 that they had the prior years.

Operator

Thank you. Our next question is from the line of Andrea Jao with Lehman Brothers. Please go ahead.

Andrea Jao - Lehman Brothers

I just wanted to make sure that I understand -- I understood your EPS guidance, so if you were going to make -- you made $2.14 in 2007. So you should at least make $2.14 this year hopefully more, but assuming $2.14, you made 156 in the first quarter. That means for the remainder of the year, you should at least make $0.58 or $0.19 per quarter and all of that is going to be from the Core Bank.

George Leis

Andrea this is George, I think what we said on the call is that we expect our EPS to grow from last year. We expected the Core Bank just given some of the deterioration that we've seen in our construction portfolio to put a little bit of a crimp on that. So, we think that we've given you all enough information to sort of figure out where you think our EPS will come in. We are confident that it will be more than last year we just --

Andrea Jao - Lehman Brothers

I was referring to like minimum number if the, more then 214 so obviously greater then $0.19 per quarter for the Core Bank.

George Leis

Stephen or Don, do you want to?

Donald Lafler

This is Don, Andrea. There will be some earnings from the RAL program in the second quarter. So, because we do have – I mean we had new loans made in the second quarter and the $61 million dollars of loans that we had outstand at March 31st the revenue on those is recognized when the loans are collected so we will still have some income in the second quarter from the RAL program that will also add to the earnings per share. So that should be taken into account in your computation.

Andrea Jao - Lehman Brothers

But doesn’t the RAL program make a bit of a loss in the fourth quarter as you prepare for the following tax season?

Donald Lafler

In the third and the fourth quarter, there has, generally speaking been small losses, perhaps $1 million or $2 something along those lines. It's not an appreciable amount.

Andrea Jao - Lehman Brothers

Gotcha and then -- just a question regarding non-interest income and I assume these items follow under other. Could you -- did you share with us the amounted or the magnitude of the reduction in mortgage valuation as well as the building write-off?

George Leis

The building write-off was approximately $640,000 including the leasehold improvements that we wrote off with that, I do not have the number for the write-down in the mortgage servicing assets at this time.

Operator

Thank you. Our next question is from line of Aaron Deer with Sandler O'Neill. Please go ahead.

Aaron Deer - Sandler O'Neill & Partners L.P

Looking at the -- at the RAL income, it looks maybe the fees or the average fee per RAL loan went down a bit this quarter, can you tell us what that average fee was?

George Leis

I don’t think so, I think it went down. I don’t think we have and there is small decrease we had a very few transactions process through the 36% APR program. But other than that, there was some decrease from the tiered pricing that we did. Again, not as substantial amount so, I'm not sure how to respond further to your question.

Aaron Deer - Sandler O'Neill & Partners L.P

Fair enough. And then can you tell me how you’re computing the anticipated 1% loss rate on the RAL’s?

George Leis

Versus total loans originated, so it is a gross figured does not take into account the securitization. So we are just simply -- I mean we are from that standpoint, the securitization is just ignored for the process we just take the total loans made, whether they are sold into the securitization or whether they’re not, and that dollar amount of loans is divided into the lose that they are incurred in order to come up with a loss rate.

Aaron Deer - Sandler O'Neill & Partners L.P

So what kind of I guess average loan then is with in the RAL program or was with in the RAL program?

George Leis

Approximately $3300, $33, $3400 is the average size.

Aaron Deer - Sandler O'Neill & Partners L.P

Okay and then just one last thing on the RAL. What was the internal funds transfer charge for the RAL deposit float?

George Leis

I don’t have a specific rate on that, we -- what we do is we put the deposit that are used for the funding and the fed funds that are used for the funding and the capitals that we have that is used for the funding and the securitization. The interest expense on each of those instruments is directly charged. We don't really have a feds transfer pricing for that. Those are booked and those are shown in the press release column under RAL at interest expense with the exception of the securitization. Securitization accounting nets the interest expense on the securitization against the fees that are received on those loans to compute the gain, where the interest expense is shown as interest expense.

Aaron Deer - Sandler O'Neill & Partners L.P

I just remember -- last year, I thought there was like 3.7 million that was – that was also computed into that number, as part of that transfer charge.

George Leis

We’ll have to look at it. I’m not familiar with that Aaron.

Aaron Deer - Sandler O'Neill & Partners L.P

Okay. I’ll circle back with there point. Thank you.

Operator

Thank you. Our next question is from the line of Joe Morford, with RBC Capital Markets. Please go ahead.

Joe Morford - RBC Capital Markets

I just wondered, if you could talk a little bit more specifically about that the nature of the review or the portfolio that this external firm did beyond just getting updated appraisals and, what kind of findings came out of that and any other actions taken?

Dave potter

This is Dave potter. At the beginning of the quarter, we were looking at this portfolio and wanted to have a very targeted review of the accounts that makeup the homebuilder portfolio in the company, particularly in the areas that we saw weakness in the first quarter. So we had them focus on the larger accounts, we also had our line people review their files very carefully to scrub accounts in this portfolio to look for deterioration and so it was really a targeted review specifically on the homebuilder portfolio.

Joe Morford - RBC Capital Markets

So that then was kind of mirrored up with the appraisal data that you got back and then drove the downgrades and provisioning in the quarter?

Dave potter

Yes -- in tandem with that review we had initiated appraisal orders on a lot of the accounts in the portfolio as well to get updated value, so that kind of came together in the conclusion of the review in terms of what our status was on each of the accounts and then as the portfolio as a whole.

Joe Morford - RBC Capital Markets

And did this review just look at the kind of out of footprint type of borrowers or was it the entire homebuilder?

Dave potter

No, it was the entire portfolio and specifically homebuilder rather than just general commercial construction.

Joe Morford - RBC Capital Markets

And then -- separately on credit can -- just talk a little bit more about what was the change in methodology for the reserving fee on funded commitments?

Dave potter

Yes. We looked at that and it’s really is in two parts, one was around the construction portfolio and commitments that we have and we decided to from a methodology standpoint increase our reserve around the likely funding probability of that portfolio, that was part of it and the other part was, we added qualitative factors as we do in our on balance sheet portfolio to the off-balance sheet as well and that droved some additional expense around inherent loss potential in the commitments around particularly about the homebuilder portfolio.

Joe Morford - RBC Capital Markets

All right fair enough. Thanks.

Operator

Thank you. Our next question is from the line of Brent Christ, with Fox-Pitt. Please go ahead.

Brent Christ - Fox-Pitt Kelton

Good morning guys. With respect to the builder portfolio and some of the updated appraisals, could you give us a sense of where some of the LTV’s were coming in, post-appraisal for some of the loans that you move to our non-performance status to this quarter?

George Leis

As you know, it really kind of depends on the specific area where in terms of what kind deterioration we saw in and within footprint it was less of a deterioration maybe a 15% to 20% our reduction, when we got into areas that were weaker like the Central Valley and like the Reno Nevada area, we saw much heavier reductions then what we had initially estimated at the end of the fourth quarter. I think then that we were looking at 30% to 40% discounts, and then we had some current appraisals come in at 50% to as lower 70% in various specific projects. Keep in mind though that appraisals are based on historic activity or sales trends at the time the appraisal was made. So, there is somewhat of that lagging indicator and without active sales in some of these markets. Sometime it’s difficult to come up with values, so with tended to happen was that absorption rates for these projects got extended out very, very far into the future. In some cases five to seven years for some of these projects, and that present value than results in a low current value.

Brent Christ - Fox-Pitt Kelton

And then how do you kind of think about the potential workout process for some of these, I mean is it something that you would like revise as quickly as possible and potentially incur some losses to do so, or is that something that’s going to be a little bit more prior to long of a work out process?

George Leis

This is George and then Dave, I would like maybe to comment on I mean that’s one of the things that we worked hard on here is the sort of remediation plans against each of those borrowers. To our long-term, customers of our banks, so Dave in that like could you just explain?

Dave potter

And Brent it really kind of depends on the individual situation, but since we are working with a lot of these people versus looking at repayment of foreclosing on collateral. We are really focusing on rapid and quick ways to remediate these loans, so we can get them back as quickly as possible to a performing status or find ways to liquidate the properties in cooperation with the borrowers. I think in the cases of kind of the larger five accounts that I have identified. There are events and process that are developing very quickly. It’s premature for me to talk about them right now, but we are pursuing very specific remediation activity with each of these right now and I’m pleased with a number of them.

Brent Christ - Fox-Pitt Kelton

I guess, if you look at your reserve coverage relative to the non-performers its comedown considerately over the past twelve months or so and I guess what the thought that the remediation process is going to move along pretty quickly and some of the price declines that you noted in, Central Valley and Reno area. I mean do you feel like your current reserves are adequate to cover the losses you might have to incur to move some of these of the balance sheet more quickly?

Dave potter

The answer is yes. We obviously acknowledge that metric looks low, but as we indicated that when we go through and do specific reserve analysis against these. We trying to these conservative as possible, but accounting rules only allow us to take a specific reserve that support by the documentation in collateral. So, again with lot of these credits, either fully covered or well covered by collateral it’s, we just can’t pick more reserves than prescribe by the documentation.

Brent Christ - Fox-Pitt Kelton

And then two last questions, one related to the portfolio reviews. Are you guys currently going through any of your other portfolios outside to homebuilder where there is much on scrutiny, whether it would be commercial construction or commercial real estate?

Dave potter

Brent we are not – we are not seeing the same kind of pressures on other portfolios as we are in the homebuilding area. So, for example on commercial real estate as we indicated for the Santa Barbara market has continued to be very strong. We haven’t seen through our footprint any deterioration, we’ve only seen about a $4 million or $5 million increase in non-accruals on our residential portfolio. We only saw about a $2 million increase in non-accruals and home equity. So, the deterioration really looks to be focused on the homebuilding side.

Brent Christ - Fox-Pitt Kelton

And then of the last question, just related to the RAL, RT business and obviously really strong increase in the transactions in the other professional tax prefers and you mentioned the one lumpy relationship where you had a pretty meaningful increase, but was there any other lumpy relationships that drove that or was it just more tax prefers that you doing business or are you talking business from -- potentially from the competitor that you think is driving in?

George Leis

Yes. Brent this is George. We worked little hard this year to get the tax business right so, we were very pleased with the results that we had -- we have driven there. We saw the online channel and to answer your question the Intuit they grew about 10% I think in that channel and we consider that sort of normal growth in that portfolio. It’s bigger than last year because of some issues that Intuit had around their documentation or online documentation, but Intuit line was really strong. We saw all of the 15% the Intuit channel group. All of independence where out there aggressively growing their business. So, we saw nice increase in that market so we were really very pleased with the results, very pleased with the credit performance, and the growth in that business.

Brent Christ - Fox-Pitt Kelton

Okay thanks a lot guys.

Operator

Thank you. Our next question is from the line of Julianna Balicka with KBW. Please go ahead.

Julianna Balicka - Keefe, Bruyette & Woods

Good morning I just want to ask a couple of follow-up questions what’s been addressed already on the call. In terms of the 33 million nonperforming loans that you had in the Central Valley and Reno last quarter. What is the current update or lost content in those?

David Porter

Julia this is Dave. We added some additional reserves to that because of the appraisal, but we’ve also been working with the borrower to bolster our position with that particular relationship and so, there is a kind of a number of moving parts there, but in general we did increase a bit on that one.

Julianna Balicka - Keefe, Bruyette & Woods

Well so how much is it, because last quarter you guys said that there was no loss content in there?

David Porter

I am sorry.

Julianna Balicka - Keefe, Bruyette & Woods

Last quarter you said there was no loss content in the 33 million. So I would just kind of wondering like is it 1 million, 2 million, 3 million or --

David Porter

I really can’t comment specifically on the credit Julianna.

Julianna Balicka - Keefe, Bruyette & Woods

Okay. That’s fine. And the second thing I wanted to find out it was on the 2.6 million of unfunded commitments provision, what is the total reserve for unfunded commitments right now?

Stephen Masterson

Roughly 3.5 million.

Julianna Balicka - Keefe, Bruyette & Woods

3.5 million?

Stephen Masterson

This is Stephen.

Julianna Balicka - Keefe, Bruyette & Woods

Okay. Great and what is the level of the unfunded commitments at this reserve is reserving for?

Stephen Masterson

The level of unfunded commitments would taking in to account really all the unfunded commitments to the bank.

Julianna Balicka - Keefe, Bruyette & Woods

All right. So what is the unfunded commitments that this or the ones that you feel that this reserve is necessary for, as opposed to all of the unfunded commitments.

Stephen Masterson

I am not sure to total unfunded dollar amount. We can get back to you on that.

Julianna Balicka - Keefe, Bruyette & Woods

That would be great and then one more question. What are your largest construction loan exposures that are not current -- that are currently performing?

Stephen Masterson

Largest performing would be probably customers in the Santa Barbara area that are in -- we probably have another two relationships in the $30 to $40 million range.

Julianna Balicka - Keefe, Bruyette & Woods

Very good. And finally in terms of your total reserves outstanding right now. What’s the qualitative fact during there?

Stephen Masterson

Qualitative factor are reserves that we estimated based up specific factors that taking to account. Really our estimates of what’s happening around each of them for example in the economy, a weaker economy would drive a dollars more dollars around estimated or put inherent loss that we yet haven’t yet identified though specific accounts that have gone either that have been downgraded or gone non accrual. So its -- it really is to represent our estimate of what’s in the performing portfolio that has been yet been identified

Julianna Balicka - Keefe, Bruyette & Woods

Right. So do you have a dollar amount of that?

Stephen Masterson

It’s about 50% of our total allowance for those qualitative factors.

Julianna Balicka - Keefe, Bruyette & Woods

Well. Thank you very much. I will step back now

Operator

Thank you. Our next questions from the line of Rajiv patel with Sinova Capital. Please go ahead.

Rajiv patel - Sinova Capital

Hay, guys thanks for taking my questions. I had a couple of questions. I just – a clarification on the guidance, the number you are using for 2007 as your earnings is that the code numbers of 187 at your 2Q gains or with it the 214 number?

Donald Lafler

The 214 is what in terms of George’s comment that our anticipation is that we will make more than that as on the 214.

Rajiv patel - Sinova Capital

So make more than 214. Okay. Okay and then on credit the can you provide what you’re -- the most recent kind of average LTV is on your builder portfolio, both the performing portfolio and the nonperforming?

Donald Lafler

The range that we have is around 60% to 70%.

Rajiv patel - Sinova Capital

That’s current or is that at inception.

Donald Lafler

That would have -- that would be current.

Rajiv patel - Sinova Capital

So than -- okay so based on your most recent appraisals, you’re performing loan -- construction loan portfolio had average LTV’s between the 60% and 70%.

Donald Lafler

Yes.

Rajiv patel - Sinova Capital

Okay and how about on the non-performers?

Donald Lafler

Well again the -- obviously much higher on those we are looking at depending on the individual account the LTV’s could be as highest -- could be as highest to 100%.

Rajiv patel - Sinova Capital

Okay and then just the final question was from the regulatory side, can you say when your next or your last safety and soundness exam was?

Unidentified Company Representative

It continue coming in July?

Donald Lafler

Early in July was last -- it was last year.

Rajiv patel - Sinova Capital

So, they are coming July will be another one?

Donald Lafler

Yes.

Rajiv patel - Sinova Capital

Okay. Thanks very much.

Operator

Thank you. Our next question is from the line of Todd Binet with Sage Partners. Please go ahead.

Todd Binet with – Sage Partners

Hi, good morning. I apologize, I was off the line so, if am a retractions some step here. My apologies, I wondered if you could comment on the provision for loan loses that occurred in Q3 of last year. I believe there is about 23 million or so taking for the RAL business? If I understood the filings correctly and if that's the case, then do you expect that the comparison would be pretty favorable given the reduction in loss of 2% or just to about 1%.

David Porter

Hi, Todd this is Dave. Last year the provision expense reflected our charge-off of the receivable that we had booked at June 30 that estimated collection of RAL – RAL’s through the end of the year 2007 and what we determined was in October that receivable was highly unlikely to be collected by December 31st. So that was a charge-offs and for the entire 2007 program, we had about a 2% loss rate on loans originated in 2007. For 2008, we are expecting the loss rate of the 2008, to be about half that our 1%. As we go into -- as we go forward and the RAL programmed this year. We are not anticipating to have a receivable going representing collections in the second half of the year. Unless we were told something very specifically that by the IRS that would lead us to believe that we should have collections.

Todd Binet with – Sage Partners

And so, I am not sure I completely follow that, but you are coming out of this year and given that you are already through April and like what’s you are seeing in and collection are along the lines of management's expectations. When you see and your not expecting a – an affected income in Q3 related to this year’s RAL program. So, from a comparison standpoint and I am missing something here, when you have a pick up of some 23 million or so, on a competitive basis.

George Leis

Yes on a competitive basis because we have the loss in the third quarter of last year. We finished off June 30th we have $30 million of loans on the books of June 30th, because prior history had indicated that we would be likely to collect that. This is what Dave explained in terms of in late October, we learned we were not going to collect that have it charged off. This year unless we have specific indication from the IRS that there is going to -- that any of the loans we have still outstanding in June 30 are in fact have a high chance of getting collected. We will charge them all off at June 30, so we do not have that overhang so the speak into the third and fourth quarter, right.

Todd Binet - Sage Partners

Right.

George Leis

So, our anticipation is that with the very substantially better collections this year. It does not mean we are going to certainly have a large charge-off in the second quarter that occurred last year in the third quarter. We are still collecting it at twice the rate or half the loan for loss rate that we have last year, so our anticipation is we are -- and as Stephen indicated earlier, we have been collecting very well on the March balances and expect to collect very well on the April balances that had incurred since the 331.

Todd Binet - Sage Partners

Okay. One follow-up question on the RAL business could you comment on the regulatory landscape?

George Leis

Yeah, this is George. There was an IRS proposal that required comments by early April and I think the entire tax preparations including Santa Barbara Bank and Trust of the capital presented papers to the IRS explaining why the RAL business is necessary and why it offered strong value to the RAL customers. So the unique process for the IRS and its going to take them while to go through all those comments given that the entire industry responded, but what we believe is that we really are not expecting real changes as a result of that that will take effect in the next season or two. If there are changes we don’t expect them to be adverse. We just think its going to a effect to way that RAL’s are going to be marketed and we think that the tax preparation industry will sort of, respond to that and accommodate those new rules. So, from the IRS perspective that’s what we think. In terms of, legislation again I don’t think there’s any real change no that either. We always seemed to have pieces of legislation float around, just like that they have in the last couple of years and we have no information that anything its sort of imminent coming from there. I think the house past a good governance bill -- past this last year as well and that good governance bill spoke to predatory lending and as an OCC regulated organization, we have not ever engage in any predatory lending activity so I won’t believe there is any concern there, so we really in the last two years have really bolstered our Washington government presence, so I feel like we have a pretty good handle on the legislative front the RAL business.

Operator

(Operator Instruction) When we do have a follow-up from the line Andrea Jao. Please go ahead.

Andrea Jao - Lehman Brother

I don’t think we have had a chance to talk about deposits during this conference call so I was hoping here, what the deposit transfer looks like at the core bank period. That numbers were lower on both a year-over-year and then quarter basis. Perhaps you could share what you’re seeing -- the cost of that and what you're seeing for the second quarter.

George Leis

Yeah, Andrea that’s a good question. Deposit gathering has been tough, we have a number of strategies that we are implementing at our retail location and that will take effect, from this part of the year going forward and those includes things from CV promotions to specialize offering in markets. We brought on a company to help us really develop those strategies. I mean we have gotten very specific in terms of demographics, in terms of street traffic, much more comparable to some of the things that occur at the larger organization so we can target those promotions and really sort of push the needle on deposits. We also talked about in other phone calls the incentive program -- we instead a high performance incentive program, that has made deposit gathering equal in commercial banking and wealth management for example to deposit growth or asset origination. So, we are waiting for those initiatives to take effect. We have been very encouraged in two of our new retail locations; we opened a new office in Simi Valley, this will be our second office in the Simi Valley market which is suburb of Los Angles area and that office we had opened three weeks and they’ve done some fantastic growth. I think they have brought in $3 million in deposits in the first month of it’s operation. In the second office -- that’s the second office. The first office we opened last year was in Oakland and that office had generated in a year about $9 million in new deposits. So -- and we have brought on maybe 15 or 20 new branch personnel to help sort of focus our sales initiative and those branch managers and the assistant branch managers are now, sort of coming on line. So I don’t want to kid anyone; deposit growth is going to be up but I think that -- I think you will see us move the needle with the new personnel, with the new initiative and with some of our new offices.

Andrea Jao - Lehman Brother

That’s great. Then let me move on to the refund transfer business…

George Leis

Sure

Andrea Jao - Lehman Brother

Fees increased $20 million year-over-year, which is pretty good. How much of that was -- is that entirely transaction driven? Were the fees per RT flat or did transaction growth make up for a declining fees per transaction.

George Leis

Transaction growth was the driver of the increasing fees Andrea. We are again very happy with the whole way the RAL season turned out for us. We think that, going forward we have returned this division back to its, high performing, high revenue contributing model that has been hear for such a long time.

Andrea Jao - Lehman Brother

Okay. Great now was the securitization a maximum of $1.5 billion at any one time?

George Leis

$1.6 billion.

Andrea Jao - Lehman Brother

$1.6 billion. Can you share with us how much actually flowed through?

George Leis

Yes, $2.1 billion

Andrea Jao - Lehman Brother

$2.1 billion. Okay…

George Leis

On high day it was 158. So, what happens is we sell through multiple times as loans to pay off, we sell again into it.

Andrea Jao - Lehman Brother

Yes and as of the day the securitization is closed right…

George Leis

Its closed as off I believe was the 18 of February…

Andrea Jao - Lehman Brother

Oh, it was zero as of February 18..

George Leis

Yes

Andrea Jao - Lehman Brother

Okay, fantastic. Now the gain in sale to the securitization also showed a decent increase; I assume that’s partly credit cost getting better and volume growth, how is the funding cost?

George Leis

The funding cost grew approximately equal on a dollar amount as to what we had in prior years on the securitization. The -- just getting the funding costs. This year we’re $4.6 million compare to $4.0 million last year and when you take into account the additional amount that we sold through it was just about equivalent, the amount sold through last year was about $1.8 billion. Now we had a substantial reduction on the cost of funding for the non sold portion for the vault and had a -- as you can see again in the table, but we had $9.6 million in interest expense last year on the unsold loans and we had $5.6 million interest expense on the unsold loans this years. So we were substantially advantaged by the cutting rates, because of large portion of our funding cores is done with overnight funds which obviously the target of the said moves as well as the short-term re portion.

Andrea Jao - Lehman Brother

No that definitely helps, great. Now with respect to the $8 million linked quarter increase in employee cost, how much of that goes away in the second quarter and how much that is now part of a regular quarterly run rate?

Stephen Masterson

The employee expenses? Part of the employees expenses was related to -- this is Stephen speaking. It was related to contract labor during the height of the RAL season and some of that will go away. Approximately $1 million of that was related to net contract labor during the height of the RAL season.

Andrea Jao - Lehman Brothers

Now how much more should it come down, because you have other seasonally elevated expenses? Or is this basically a good run rate ex-RAL?

George Leis

It is a good run rate ex-RAL relatively speaking

Andrea Jao - Lehman Brothers

Okay, good. Good to know.

George Leis

And I know all that’s based on the incentive plans of the bank and the high performance incentives based on bank performance.

Andrea Jao - Lehman Brothers

Good. Last question, will your NP ratio continue to reach higher and how confident are you that net charge-offs will remain relatively low. I mean -- when you mean relatively low net charge-offs, do you mean something closer to the first quarter level or can we inch up to the first quarter of ’07, which for the bank alone was north of 80 basis points?

George Leis

Andrea…

Andrea Jao - Lehman Brothers

To wide range.

Dave Porter

Yeah. Andrea it’s Dave. First quarter of ’07 included the leasing and indirect auto portfolios that had much higher loss rates than the rest of the portfolios. So, I wouldn’t use the first quarter ’07 as a good comparison because those portfolios are relatively small actually contributed the majority of the losses at -- well, while we had them. In terms of going forward I think we were at about 16 basis points in the first quarter and it’s probably tough to estimate given the economic environment this year about, what that’s going to be going forward. I -- if there was a tick in that they would probably represent economic issues.

Andrea Jao - Lehman Brothers

Okay. And non-performers…

Dave Porter

What was your first question again?

Andrea Jao – Lehman Brothers

Non-performance will they continue to inch higher, do you see peak let say in the second or third quarter of this year?

Dave Porter

Yes, it’s tough to -- it’s really tough to estimate of timing of the peak and Andrea, I’m not sure I can do that.

Operator

Thank you. And our final question comes from the line of Trevor Morris with UBS. Please go ahead.

Trevor Morris - UBS

I’m addressing this question to corporate policy, was there not an indication last summer or at the end of the second quarter that you’re going to deemphasize the tax program to some degree. In order to improve quality of earnings and perhaps reemphasize the core bank. Did I miss interpret that?

George Leis

Well this is George Leis. What we said was that we were going to stabilize the RAL business that would give us the -- give our -- and invest the proceeds that are in the Core Bank and what we said on every conference call was that the best way to grow the core bank -- focus on the Core Bank was to focus on its fundamentals, which is what we are doing, stabilizing the RAL business which caused what we thought a lot of volatility in our stock price. So, we had a sort of two-pronged approach, getting the RAL business fixed, which we think we’ve done, which we think we’ll take and as we can continue to deliver on that promise of stabilized earnings streams in the RAL business, we think that we will take some of the volatility out of the stock price and focus on growing the Core Bank in the three areas that I‘ve talked about since I became CEO, which is our Community Banking, which is our retail branch structure. Our Commercial Banking, which is self-explanatory and growing our wealth management business, which we continue to do both organically and through acquisitions, the most acquisition of the Core Bank being R.E. Wacker, the registry investment advisor in San Luis Obispo.

Operator

Thank you and there are no additional questions at this time. I’ll turn it back to management for any closing remarks.

George Leis

Well, I just want to say thank you all for attending our first quarter call and we’ll be in touch. Thank you again. Bye, bye

Operator

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using ACT teleconferencing. You may now disconnect.

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Source: Pacific Capital Bancorp Q1 2008 Earnings Call Transcript
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