East West's dismal profit report casts long shadow

Stocks of major U.S. banks have rallied from their first-quarter lows. But investors keep backing further away from shares of Southern California community banks, particularly those known for their focus on Asian ethnic communities.

Fear of rising loan losses has hammered stocks of Southland banks including East West Bancorp, Cathay General Bancorp and Center Financial Corp. in recent weeks.

Pasadena-based East West deepened the gloom late Tuesday when it reported first-quarter earnings of just $5 million, or 8 cents a share, down almost 90% from a year earlier. The bank set aside $55 million for potential loan losses, citing the "unprecedented decline in the real estate market and economic downturn."

East West’s stock tumbled nearly 11% on Wednesday to $14.16, its lowest close since 2002. The price was $19.75 as recently as March 25.

East West and its peers tend to focus on small- and mid-size businesses, and have been active lenders for years in commercial real estate as well as for residential construction and land loans. Julianna Balicka, a banking analyst at Keefe Bruyette & Woods in San Francisco, said in a report today that a relative few of East West’s construction and land loans were troubled so far, but for a bank with $11.8 billion in assets, "it takes only a few loans to cause significant losses."

Investors’ concern, not surprisingly, is that the Southland banks are early in the process of dealing with the fallout from the residential real estate bust on the rest of the regional economy. If loan losses accelerate, the banks could be forced to follow Citigroup, Wachovia and other giants by slashing dividend payouts and selling stock to raise fresh capital, thereby diluting current investors' stakes. Balicka figures East West will suspend its dividend in the third quarter.

Ominously, East West said in its earnings report that it no longer would provide guidance on 2008 earnings, "given the uncertainty surrounding the economy and real estate market and the potential impact this will have to the company."

Joe Morford, an analyst at RBC Capital Markets in San Francisco, on Wednesday dropped his "buy" rating on East West. He acknowledged that "we are late to this call with the stock down more than 50% over the past year, but we believed the company would manage this downturn better than most. That no longer seems to be the case."