Positive pessimism: analysts applaud East West's beefed-up provision for potential loan losses.

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CALIFORNIA'S battered housing market is weighing heavily on most Southland lenders, but East West Bancorp Inc. may already be on the rebound--and investors have taken notice.

One of Southern California's largest financial institutions, East West has gotten stung by its exposure to the local real estate market, particularly in the Inland Empire. But the Pasadena-based holding company for East West Bank has begun taking some bitter medicine to right its finances.

The company, which has brought in a third party to assess its portfolio risks, surprised analysts and investors last month by setting aside an exceedingly large provision for possible loan losses in the second quarter.

The company allocated $85 million to cover future loan losses--up 55 percent from the previous quarter.

"They took a very sizable provision for loan losses," said Aaron James Deer, an analyst with San Francisco-based Sandier O'Neill & Partners L.P. "(But) by building that reserve they're better positioned to be able to bear the brunt of any losses that they do see in their portfolios. They're basically realizing some of those (future) losses now."

Deer said the tactic should allow the company to reduce its future loss provisions dramatically. East West executives said the provision could be as low as $20 million by first quarter 2009.

By taking such a large provision now, however, East West sacrificed its second quarter earnings. The company reported a loss of $25.9 million, or 41 cents a share. Analysts had expected a profit of 5 cents per share.

Still, the company's attempt to address its problems early has resonated on Wall Street, where its stock price surged in spite of the poor earnings.

Once a target of short-sellers, East West was among the top LABJ 200 gainers for the week ended Aug. 6, rising 19 percent to close at $14.26. Shares have more than doubled since July 1, but in a reflection of how much all bank stocks have been battered, it is trading at only a fraction of its 52-week high of $38.42 reached in October.

Chief Executive Dominic Ng said the loan loss provision should quiet concerns about the company's future.

"We are comfortable that as of June 30 we are well reserved and will be able to meet future credit challenges with significantly less credit provisioning than the first half of the year," said Ng in a July 25 conference call. "We believe the East West business model and balance sheet are very strong and position us quite well as this cycle bottoms out."

Housing falls

With 72 branches located mostly in California, East West offers a range of banking services, as well as real estate and construction loans. Started in 1973, the bank has become one of the country's largest and fastest-growing ethnic Chinese banks, increasing its asset base by more than 20 percent annually over the last 10 years to $11.8 billion.

But like many lenders in recent years, East West could not resist the lure of Southern California's booming housing market. And California has been one of the states hit hardest by the real estate meltdown.

Though East West stayed away from sub-prime loans, it has been hurt as rising default rates have plagued even issuers of prime loans. That has been bad news for East West, which has about $7 billion tied up in real estate loans.

However, Ng moved aggressively in the spring to shore up capital levels after a poor first quarter. East West raised $200 million in April in a convertible preferred stock offering.

That move has begun to look prescient as many banks--including IndyMac Bancorp, recently taken over by federal regulators, and PFF Bancorp--have since found it too difficult to raise capital in the current economy.

East West reported that its total risk-based capital was a bit more than 13 percent at the end of the second quarter, essentially meaning it had $13 in reserves and other capital for every $100 in loans. To be considered "well capitalized," a bank must have a risk-based capital ratio of at least 10 percent.

"Certainly at this point they're well positioned as far as their capital levels," Deer said. "Their timing was very good because at the time, arguably, they didn't necessarily need to raise capital. Having raised it when they did looks like a pretty wise move on their part."

In addition, the company reported that it has conducted a comprehensive internal review of its loan portfolio, and is nearly through a third-party appraisal of its commercial construction loans. As a result of the reviews, Ng said East West will "be able to minimize the losses much better than many of the other banks."

Chris Stulpin, an analyst with D.A. Davidson & Co., recently raised his rating on East West's stock to "buy." He cited the company's capital-raising moves and efforts to address its problem loans as positive indicators.

"We believe the worst is behind the bank," Stulpin said in a research report. "East West is run by a conservative, realistic and proactive management team. The bank was early to the capital markets and we think it is early in addressing problems within the loan portfolio as well."

By RICHARD CLOUGH Staff Reporter