The slumping market for commercial real estate -- viewed by many as the next big shoe to drop on the economy -- now threatens to drag down regional banks as they struggle to collect on loans made against shopping centers and office buildings.
Seriously overdue loans against commercial developments have shot up dramatically in recent months, as delinquencies snowball on construction loans and mortgages for office buildings, malls and apartments.
That's bad for giants like Bank of America Corp., Wells Fargo & Co. and JPMorgan Chase & Co. But it's even worse for smaller banks, which stepped up lending to local developers and businesses as a way to stay afloat after the national institutions grabbed big-ticket consumer businesses such as home loans, credit cards and checking accounts.
That's especially true in California, where unemployment exceeds 11% and commercial real estate is being pummeled.
"Commercial lending is our bread and butter, the lion's share of our business," said Dominic Ng, chairman of East West Bancorp, which with $12 billion in assets is the second-largest bank based in Los Angeles County.
The Pasadena bank, which has expanded over many years from its Chinese American base into Southern California's banking mainstream, set aside $226 million to cover loan losses last year, up from $12 million in 2007. The bank lost $49 million in 2008, compared with a profit of $161 million in 2007.
Land development and construction loans, the main problem so far for East West, total about 20% of the bank's loan portfolio. Now Ng says he is nervously watching delinquencies on commercial mortgages -- about 40% of East West's loans.
Uncollectable commercial mortgages quadrupled over the last three quarters of 2008, according to data reported to regulators. Uncollectable commercial construction loans increased eightfold during the same period.
Most of the loans were secured not only by the properties but also by the personal fortunes of the developers. Now, many have been wiped out by the recession, making the loans uncollectable.
"Some of the borrowers say: 'Go ahead, come after me. I have absolutely nothing left,' " Ng said. "The net worth completely disappeared in 12 months."
East West's plight is repeated at financial institutions throughout the state, as well as other places hit hard by the real estate crash, including Florida, Nevada, Arizona and Oregon.
According to the data filed with regulators, uncollectable commercial loans tripled at City National Corp. of Beverly Hills in the last three quarters of 2008, as did similar loans at California Bank & Trust of San Diego.
Throughout the banking sector, seriously delinquent loans for construction and land development shot up nearly ninefold over the last two years, according to the Federal Deposit Insurance Corp.
At one of the banks hit hardest by such lending, Los Angeles-based Preferred Bank, Chairman Li Yu said he was hopeful that tanking housing prices were beginning to stabilize.
"The same thing cannot be said of commercial real estate," Yu said. "That has to do with the economy and joblessness."
According to Yu and others, the troubles in commercial real estate are really just beginning. Even though the percentage of such loans that are uncollectable is way up, the overall numbers are small.
But industry watchers say the wave is building.
As commercial loans go bad, it will be particularly hard on regional banks, said Joe Morford, a San Francisco-based analyst for RBC Capital Markets, because their main customers are the small and medium-size businesses whose ranks include many developers.
"They exist for the small-business customer, the real estate developer and the entrepreneur," Morford said, a role that makes their health crucial for the greater economy. Morford has warned investors to be cautious about all three of the biggest L.A. County-based banks: East West, City National, and Cathay General Bancorp of Los Angeles.
Morford said in a report last week that commercial real estate and business lending problems are worrisome at Zions Bancorp, a Salt Lake City lender that is the parent of California Bank & Trust and operates in 10 Western states; and Umpqua Holdings Corp., an Oregon bank that operates from Napa, Calif., to Bellevue, Wash. He rates Umpqua, Zions, East West, Cathay and City National "sector perform," his middle rating, but says he is "particularly concerned" about these banks.
He recently has taken road trips to the Central Valley, Inland Empire and Orange County to show investors just how battered the California economy really is, e-mailing them photos of "for lease" signs on offices, warehouses, retail shops and condominiums.
Ng, of East West Bank, said his institution would remain solid because it had been conservative in the amount it lent on commercial properties.
Other bankers also said they expected to steer through the commercial real estate troubles, although many acknowledged that losses in the sector would rise.