Pacific Capital Bancorp executives may have thought they had good explanations for why the company reported a 12% drop in its second-quarter earnings and lowered its full-year earnings estimates, but investors were not moved.
The stock price, which hit its 52-week high July 14, has plummeted since the $6.2 billion-asset Pacific Capital disclosed in its earnings release the next day that net income fell because of a drop in collections on its lucrative tax-refund-anticipation loans.
Pacific Capital's lead subsidiary, Santa Barbara Bank and Trust, is among the handful of banks that grant immediate loans to taxpayers who file their returns electronically with the Internal Revenue Service and who expect refunds. Pacific Capital is repaid the loan when the IRS grants the refund, and sends it directly to the bank.
Executives said in the release - and later in a conference call - that the Internal Revenue Service would probably pay most of those loans by yearend, and that when all is said and done 2005 stands to be the Santa Barbara, Calif., company's best year yet for its tax-refund loan business.
They further pointed out that revenue from the refund-loan business rose 47% in the first half of 2005 compared with last year's first half as a result of a change in Pacific Capital's contract with the tax preparer Jackson Hewitt.
But analysts say investors have little patience these days for such explanations. Though analysts are confident the stock will recover, Michael McMahon of Sandler O'Neill & Partners LP in San Francisco said that many investors are probably too confused right now to comprehend the adjustments to Pacific Capital's refund-anticipation business.
"The market doesn't want to hear lengthy stories - the more you have to explain, the more difficult it is to convince investors that it's OK," Mr. McMahon said.
Pacific Capital's stock closed at $32.52 Tuesday, down 18% since mid-July. The decline followed what had been an impressive run since Pacific Capital said in mid-April that first-quarter net income was up 39%, to $59.4 million, due largely to a 58% jump in refund-loan revenue.
Donald Lafler, Pacific Capital's chief financial officer, said first-quarter earnings increased substantially because the IRS paid most of the refunds in the period (typically it waits and pays a good portion in the second quarter), more people took out such loans, and the new contract with Jackson Hewitt gives the bank more money for each loan for taking on virtually all the credit risk.
For those same reasons, however, revenue fell in the second quarter. The IRS held more loans for tighter scrutiny than in the first quarter, and Pacific Capital now has to assume the risks instead of Jackson Hewitt.
"The revenues are so much greater that even a small drop in collections can add up," Mr. Lafler said in an interview. "But in the end, we've made so much more money that we'll more than make up for it."
Under the old contract with Jackson Hewitt, of Parsippany, N.J., the tax preparer ate the first $50 million of losses when the IRS refused to grant refunds and shared the rest of the losses with Pacific Capital. But since losses were always less than $50 million, Pacific Capital never had to take on any losses; if the IRS refused to pay a refund, Jackson Hewitt still repaid the loan to Pacific Capital.
Now the arrangement has been reversed, and Pacific Capital essentially takes on all the risk - if the IRS refuses to pay, the bank has to charge off the loan.
So far the IRS is paying roughly the same percentage of loans that it has historically paid, Mr. Lafler said. It generally holds a certain percentage of loans, selected at random, to scrutinize more closely for fraud or mistakes that would reduce or completely erase the refund. (Garnishments for liens on a refund such as past-due child support or from other banks for unpaid refund-anticipation loans in years past are generally taken out in the first quarter.)
About $7 million of refund-anticipation loans has yet to be collected, and Pacific Capital expects to collect much of that during the third and fourth quarters. Over all it expects to clear about $59 million of pretax income for the year from the business line.
Pacific Capital also lowered its guidance for 2005 earnings to a range of $2.14 to $2.20. But Mr. Lafler said it did this mostly because it had raised the guidance to a range of $2.30 to $2.38 after the first quarter's earnings were so strong. Previously the company had projected $2.02 to $2.12.
Both Mr. McMahon and Brett Rabatin, an analyst at First Horizon National Corp.'s FTN Midwest Securities Corp., say that after several quarters - particularly after another great first quarter in 2006 - investors should get used to the vagaries of Pacific Capital's new contract with Jackson Hewitt, and will again reward the company.
"It's a complicated business, but nonetheless, management has shown to be very adept at executing it," Mr. Rabatin said. "It's very profitable, and it provides them with a lot of capital that management can leverage in its central California footprint."
Indeed, Pacific Capital has used the money to make more loans and buy more banks. In the second quarter its interest income rose 21%, to $86.3 million, on strong growth in commercial loans, helped by the company's gradual expansion farther north and south into the San Fernando Valley near Los Angeles.
On Aug. 1, Pacific Capital completed its purchase of the $280 million-asset First Bancshares Inc., the parent of First Bank of San Luis Obispo. In its second-quarter earnings release, company officials said the acquisition should further boost loan growth and help Pacific Capital achieve double-digit earnings growth for 2005.
