DBRS Confirms Pacific Capital Bancorp at BBB (high); Trend Stable

DBRS has today confirmed the ratings of Pacific Capital Bancorp (PCBC or the Company) and its bank subsidiary, Pacific Capital Bank, N.A., including PCBC’s Issuer and Senior Debt rating of BBB (high). The ratings action follows a detailed review of the Company’s operating results and financial fundamentals. All trends are Stable.

The Company’s ratings are underpinned by a well-established and low-risk community banking franchise along the central California coastline that produces sustained profitability and stable earnings. The ratings also take into account PCBC’s strong niche in the nationwide Refund Anticipation Loan (RAL) and Refund Transfer (RT) programs, where it processes over 30% of all transactions in the industry. Historically, RAL/RT has been the more profitable business line, however, higher than expected fraud rates within the RAL program in 2007 resulted in much weaker results. This highlights the volatility and higher credit risks of this particular business. DBRS notes that the Company has instituted tighter controls and dropped certain higher-risk products, which should significantly improve results in 2008.

Overall, net income in 2007 grew 7% to $100.9 million as loan sales, growth in trust and advisory revenues, lower securities losses and strong expense control more than offset the weaker results from RAL/RT. In the second quarter, the Company sold its Indirect Auto Finance and Commercial Equipment Leasing portfolios, which boosted net income by $12.2 million net of related expenses. This transaction also lowered PCBC’s overall credit risk profile as these loans had underperformed relative to the remaining core bank loan portfolio. Total non-interest expenses declined by 13% as the Company began to execute on expense reduction initiatives including a reduced headcount.

For the year, provisioning for RALs increased 151% to $92 million, which significantly impacted RAL/RT results. While the business remained profitable, net income slipped 58% to $22 million as PCBC experienced higher loss rates from increased fraud by both tax preparers and customers. The unusually high rate of fraud compelled the Company to tighten its controls such as more robust fraud screening and the elimination of riskier products such as pre-file and holiday loan products where most of the losses originated.

Positively, the 2008 RAL program, with its increased fraud controls, is off to a good start. To date, PCBC has received two payments from the IRS with higher payment rates relative to historical experience. Even with the tighter controls, the Company expects higher volumes in both its RAL and RT programs.

The Company does have a significant Commercial Real Estate concentration. During the fourth quarter, one large $33.5 million residential homebuilder loan relationship went on non-accrual status and was the primary reason non-performing loans jumped to 1.37% of loans held for investment in the fourth quarter from 0.41% in the previous quarter. Even with recent appraisals that have been discounted, PCBC expects the loss content to be minimal. Excluding RALs, net charge-offs did remain stable at 0.37% of average loans for the year. Although further asset quality deterioration is likely in the prevailing negative credit cycle, DBRS believes that PCBC is unlikely to suffer further material losses given its conservative underwriting culture, improved RAL controls, attractive footprint and the sale of two riskier loan portfolios in 2007.

Given the Company’s strong market position along California’s attractive central coast, sufficiently diverse revenues, and tighter controls surrounding the RAL business, DBRS expects PCBC to continue to deliver solid earnings and profitability metrics, as well as maintain strong financial fundamentals in line with its current ratings and Stable trend.

Upward ratings momentum could result from material improvement in core funding and growth in its fee income contribution. Negative ratings pressure could result from failure of fresh controls to minimize fraudulent transactions and sustain good asset quality in RAL, an increased reliance on wholesale funding or marked and sustained deterioration in asset quality that would lead to weaker earnings.

Headquartered in Santa Barbara, California, PCBC is a commercial bank holding company for Pacific Capital Bank, N.A. At December 31, 2007, the Company reported $7.4 billion in assets.

Note:
All figures are in U.S. dollars unless otherwise noted.