Pacific Capital Bancorp Inc. plans to sell its tax division — its most profitable line — after regulators blocked the company from making new tax loans in the coming year.

The $7.9 billion-asset company in Santa Barbara, Calif., announced last week that it has a letter of intent to sell its e-filing financial services division, which offers refund anticipation loans and refund transfer tax products, to an unidentified private-equity firm for an undisclosed amount.

The company, which has not met the capital requirements set by a regulatory order, said the Office of the Comptroller of the Currency told it on Dec. 18 that it would not get regulatory approval in 2010 to originate tax loans, which typically swell its balance sheet by as much as 50%. At the end of the third quarter, the company needed a minimum of $263 million to meet the required capital levels, according to one analyst.

George Leis, Pacific Capital's president and chief executive officer, said this sale would preserve the company's capital ratios but would not let it meet the regulator's enhanced capital requirements.

"It is an important step, but it is not the only step to meet those capital requirements," Leis said in an interview Thursday. "We continue to look at all options that are available."

In addition to hiring the investment banking firm Sandler O'Neill & Partners LLC, Pacific Capital is planning further cost-cutting as part of its plan to return to profitability, Leis said. In the past year the company has cut 20% of its work force.

Pacific Capital also is reducing the size of its balance sheet, which improves the capital ratio. So far this year, it has reduced its asset size by almost $1.7 billion.

The tax division that Pacific Capital is seeking to sell has a lackluster future. Tax-return lenders have been taking heat from state and federal regulators for allegedly predatory lending practices. Also, as recession-weary consumers seek less expensive refund options and the Internal Revenue Service picks up the pace of its refund payments, profits from tax-refund anticipation loans are drying up.

Industrywide, requests for refund anticipation loans fell by more than 15% in the 2009 tax filing season, to 8.4 million, according to a report published in June by the Government Accountability Office.

Some analysts think the business segment may not recover.

As a result, industry watchers said it is unlikely Pacific Capital will get a good price for the division.

Terry Keating, managing director in the Chicago office of Amherst Partners LLC, an investment bank, said that tax-refund lenders have been controversial so it is not surprising that a troubled banking institution would be barred from running such a business.

"They are typically high-interest loans, and the view is that you are paying to borrow your own money," Keating said, adding that Illinois Gov. Pat Quinn ordered state regulators in November to stop consumer lenders from making such loans. "So if you are already under a capital order, this is an activity your regulators are not going to want."

Keating predicted that Pacific Capital would end up selling the unit at a steep discount because of the regulatory order and the lack of appetite for tax-refund businesses. "I don't think it will be a question of getting it done," he said. "I think the question will be: At what price?"

Pacific Capital began originating tax-refund anticipation loans in 1993. In a typical year the line of business accounts for roughly 40% of the company's income, Leis said, though in the past year it generated virtually all of the company's revenue.

"The refund anticipation loan business has been so good to our company over so many years," Leis said in Thursday's interview.

Pacific Capital's subsidiary bank had agreed to achieve a leverage ratio of 9% and a total risk-based capital ratio of 12% by Sept. 30 but instead reported a 5.6% leverage and 10.8% total risk-based capital ratio.

Meanwhile, the company's losses have mounted.

In the third quarter, it reported a net loss of $40.7 million available to common shareholders, compared to a loss of $47.5 million the year earlier. Pacific Capital's net loss for the first nine months was $411.3 million, compared with net income of $19.1 million the year earlier.

Richard Levenson, the president of the Western Financial Corp. investment bank in San Diego, said the sum that Pacific Capital must raise is daunting but in his view not impossible.

"That's a big number," he said. "But we are seeing signs of various funds coming back in. I would think Pacific Capital, to come up with that much money, would need three or four large sources rather than just one … . I think there is hope."

Yet the company's asset quality continued to deteriorate in the third quarter. It provisioned $42 million for loan losses in the quarter, bringing the total for the year to $390 million. Nonperforming assets grew to 4.87% of total assets, up 264 basis points from the year earlier and 71 points from June 30.

Still, Leis said, problem loans are showing signs of improvement.

"We are still seeing losses and still seeing reserve build, but velocity in the third quarter slowed down, which is encouraging," he said. "In our footprint the thing we have seen in the decline in appraised values is a drop of 50%, 60% or 80%. Those values can't drop that much further. As of the third quarter, there was a slowdown in the velocity of problems. It doesn't mean we are around the corner or over it, but it is an encouraging sign."

In June Pacific Capital announced that it would defer payments on $69.4 million of trust-preferred securities and suspend dividends on its common and preferred shares — including a $181 million investment from the Treasury Department's Troubled Asset Relief Program.

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