Even a flurry of profit warnings from Oregon banks in the last week could not prepare investors and analysts for the bomb West Coast Bancorp dropped late Tuesday.
The Lake Oswego, Ore., company announced after the markets closed that it would take a $30 million loss provision for the fourth quarter and that it expects to report a loss of as much as 50 cents a share.
Analysts had expected the provision to rise as a result of a downturn in the state's housing market, but the amount was more than 10 times what some had predicted and 5.5% of West Coast's overall real estate and construction loan portfolio.
So what went wrong?
West Coast is not saying much beyond the press release, but analysts said the bulk of the anticipated loss could be related to fraud committed by customers who took out loans for construction of custom-built homes.
The news of the $30 million provision sent West Coast's shares tumbling to a six-year low Wednesday. They closed at $13.63, down 15.4% from Tuesday's close.
The $2.6 billion-asset company is expected to announce its fourth-quarter and yearend earnings Jan. 17. Robert D. Sznewajs, its chief executive, said in a brief interview Wednesday that in a conference call next week executives would elaborate on why the provisioning was so large — and what the actual loan losses would be in the first quarter and beyond.
Analysts had expected some deterioration in credit quality as the housing slide that had already hit such states as Florida and California starts to ripple through the Pacific Northwest.
Indeed, in the last week several Oregon community banking companies — including the $2.4 billion-asset Cascade Bancorp in Bend, the $900 million-asset Pacific Continental Corp. in Eugene, and the $1.1 billion-asset PremierWest Bancorp in Medford — had warned of increases in problem loans in their residential construction portfolios.
But analysts say West Coast's huge provisioning could also be a result of fraud within its custom home construction portfolio. In its so-called "two-step" program, West Coast made construction loans to individuals building custom homes, with the intention that a third-party lender would then make a take-out permanent loan to finance the mortgage.
However, analysts say West Coast encountered problems when the other lenders stopped making the take-out loans because of the collapse of the secondary market for such loans and when some of the individuals had subsequent problems selling the custom homes.
The two-step loans program is designed only for borrowers who intend to live in the custom homes, but analysts say there is evidence that loans were taken out fraudulently by speculative developers who could not flip the homes when the market soured. (West Coast discontinued the two-step program in October.)
James Bradshaw, an analyst at D.A. Davidson in Portland, Ore., said that he had expected West Coast to increase its provision in the fourth quarter by $2 million to $4 million, and that he was "saddened" apparent slack underwriting standards caused the actual provision to be larger than it has recorded "for all of this decade to date."
He said he had held West Coast's underwriting standards "in pretty high regard, but it turns out that maybe there was a gap in the system."
Mr. Bradshaw has cut his 2007 earnings per share estimate to $1.02 from $2.02, and cut his 2008 forecast to $1.96 from $2.05, to reflect slower loan growth and higher operating costs related to loan collection issues.
Brett Rabatin, an analyst at First Horizon National Corp.'s FTN Midwest Securities Research Corp. in Nashville, said he hopes that in Wednesday's conference call West Coast will give a clearer picture of anticipated first-quarter losses in the portfolio.
Specifically, Mr. Rabatin said he wonders whether the current provisioning will result in partial writedowns of more nonperforming loans or whether there will be complete losses on some of the loans made to the "flippers."
Jason E. Werner, an analyst at Howe Barnes Hoefer & Arnett Inc. in Chicago, said he fears West Coast's 2008 credit quality problems may go beyond the two-step program. "They still have exposure to the slowdown in development, construction, and land development," Mr. Werner said. "Given the weakness" in credit quality "that their competitors have already shown, I'm concerned that overall provisioning levels will be elevated, and credit quality will be an issue well into 2008."
Still, West Coast will likely make "decent money" in 2008, though it will be a more "subdued" profit, Mr. Bradshaw said.
"It certainly will be more stable than the fourth quarter's results," he said.
