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Estimated reading time: 3 minutes, 39 seconds

The Santa Barbara Fire Sale: How the Golden RAL Goose Died

George LeisPacific Capital Bancorp CEO George Leis said the fact his company would receive about $10 million in proceeds from the sale of its refund loan and refund transfer business was disappointing. That was a major understatement because the forced sale of the tax business of the company's subsidiary, Santa Barbara Bank and Trust resulted in its disposing of a unit that had produced just under $132 million in net interest income over the last two years.

"This is a disappointing amount [the proceeds] for a business that has contributed such a large portion of the banks’ earnings throughout most of the decade," Leis told analysts during Monday's conference call about results for the fourth quarter and year ended December 31. The business would have been even more profitable, except that after the Internal Revenue service last year started holding onto returns with RALs, the bank increased its provision for loan losses to $74.5 million for 2009, more than three times the $21.8 million provision for 2008.

Pacific made the sale after the Office of the Comptroller of the Currency in December refused to approve Santa Barbara's RAL program for the current tax season. That action stemmed from Pacific's failure to achieve leverage and risk-capital ratios that it had agreed to early in 2009.

Meanwhile, the sale left many tax preparation services scrambling to find funds for refund loans with Jackson Hewitt Tax Services with funds for only 50 percent of its anticipated RAL volume. The bank's tax operations were sold to the Santa Barbara Tax Products Group, which was the same staff but which was backed by an equity investment group. However, the new company, backed by Meta Bank, is offering only assisted transfers, not refund loans. Meta Bank had been issuing and managing cards under the Santa Barbara unit's prepaid debit card program and providing the lines of credit.

With mortgage-back securities souring the economy, the bank had already been forced to change the way it financed its refund loan business. Through 2008, it securitized part of its loan volume and recognized the net gain on the sale of the loans. In the first quarter of 2008, Pacific securitized $2.2 billion of its $6.8 billion in RALs and recorded a gain of $44.6 million on their sale.

But it was unable to get a securitization facility in the fourth quarter of 2008 and this had important impacts on the entire banking operation. Securitizing RALs removed them from Pacific's balance sheet, helping it sustain its capitalization levels. To help underwrite the 2009 RAL program, the bank raised $1.28 billion through brokered CDs and also utilized a $524 million syndicated funding line. Since it had to fund the entire RAL program on its balance sheet, that also decreased the profitability of the tax operations because of increased interest expense.

On the income statement side, since the company maintained ownership of the RALs, its interest income from that source jumped to $151.6 million for the nine months ended Sept. 30, 2009, compared to $108.8 million in the same period in 2008. Correspondingly, non-interest income from RALs, which was how the gain on sales of securitized RALs were recorded, dropped to zero for 2009 from $44.6 million in 2008.

Pacific has not yet filed its form 10-K for 2009. However, the report for 2008 also shows the extent of the relationship with Jackson Hewitt. The bank paid Jackson Hewitt $46.3 million for 2008, $44.5 million in 2008 and $54.7 million in 2006 for marketing and technology fees associated with the RAL and refund transfer programs. In exchange for the Santa Barbara got all the interest and fee income from the tax chain's bank products programs, as well as assuming all of the risk.

Although Jackson Hewitt had a similar agreement with Republic Bank, it was, Santa Barbara that provided a majority of its RAL funds.

Bob Scott
Bob Scott has provided information to the tax and accounting community since 1991, first as technology editor of Accounting Today, and from 1997 through 2009 as editor of its sister publication, Accounting Technology. He is known throughout the industry for his depth of knowledge and for his high journalistic standards.  Scott has made frequent appearances as a speaker, moderator and panelist and events serving tax and accounting professionals. He  has a strong background in computer journalism as an editor with two former trade publications, Computer+Software News and MIS Week and spent several years with weekly and daily newspapers in Morris County New Jersey prior to that.  A graduate of Indiana University with a degree in journalism, Bob is a native of Madison, Ind
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