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Future cloudy for Downey Savings

The Newport Beach lender posts a wider loss and may seek help from the U.S. bailout.

October 23, 2008|William Heisel and Tiffany Hsu | Heisel and Hsu are Times staff writers.

Not long ago, there were five big players in the business for high-risk home loans known as option ARMs.

Who would have guessed that the last one standing would be the smallest: Downey Savings & Loan. Judging by its latest earnings report, however, Downey's own future is far from certain.

Citing the toll of escalating foreclosures, holding company Downey Financial Corp. on Wednesday reported a third-quarter loss of $81.1 million, or $2.89 a share, from $23.4 million, or 84 cents, a year earlier. Deposits fell nearly 10%, to $9.6 billion.

Company officials declined to comment. But in a statement, the Newport Beach firm indicated that it would look for help from the $700-billion federal bailout package. The Treasury Department has said that it might buy stakes in regional and community banks.

For The Record
Los Angeles Times Friday, October 24, 2008 Home Edition Main News Part A Page 2 National Desk 2 inches; 74 words Type of Material: Correction
Downey Financial earnings: An article in Business on Thursday about Downey Financial Corp.'s quarterly results said the company failed to meet the regulatory minimums set for its core capital ratio and risk-based capital ratio. The Newport Beach savings and loan actually exceeded those minimums. It had a core capital ratio of 7.48%, about half a percentage point above the minimum, and a risk-based capital ratio of 14.5%, half a percentage point above the minimum.

"We are reviewing the recently announced governmental programs to determine which programs, if any, might be available and appropriate for us," Chief Executive Charles Rinehart said in a news release.

Downey was among the top five producers of adjustable-rate mortgages in which borrowers had the option of making low payments initially -- the so-called option ARMs. But rates eventually ratcheted up, and when home prices started falling, borrowers found themselves owing more than their homes were worth and stopped paying.

Defaults on these loans contributed to the forced sale or collapse of mortgage lenders Washington Mutual Inc., Wachovia Corp., IndyMac Bancorp. and Countrywide Financial Corp. That led many investors to bet that Downey may be next. The stock price has fallen 94% this year and lost 16 cents, or 7.9%, Wednesday to $1.87.

Downey and other struggling institutions may get a boost from the Treasury Department, which plans to pump $250 billion from the rescue package into bank shares. Apart from nine major banks already named, it's not clear which other players would get an infusion of capital -- although industry analysts predict that the Treasury Department would choose the institutions with the best chance of survival.

Downey has a long history of serving the Southland community, but its weakness may cause it to be sacrificed in favor of healthier banks, said Richard Eckert, chief financial officer and risk manager for Lahde Capital Management in Los Angeles.

"Sometimes regulators just want to make an example of someone, and Downey was one of the more notorious option-ARM lenders, though there were plenty of others that have already been punished," he said.

"When the government ultimately performs the triage, I don't know what side of the ambulance Downey is going to be laid down on. Seven-hundred billion dollars is a lot of money, but I'm not sure that the Treasury and the Fed's coffers are limitless, so at some point, they will have to play God."

Like other lenders, Downey has stopped making option-ARM loans and is looking for new investors or a buyer. The company is also trying to raise cash by selling real estate holdings, including its Newport Beach headquarters, and last week laid off 200 people in its mortgage lending department to cut costs.

In its earnings report, Downey said the expense of dealing with foreclosed homes contributed to a 64% increase in its operating costs. Bad loans -- those deemed uncollectable -- rose to nearly $100 million, a tenfold increase. In all, Downey's percentage of so-called non-performing assets grew to 15.7% of its total assets.

On the positive side, the bank beat expectations by losing less money than expected. It also owns an enviable branch network, with 175 offices in California and Arizona.

Deposits are down 10% from a year earlier, to $9.6 billion. But that reflects a slight improvement; earlier this summer, deposits had dropped as low as $9.4 billion.

Downey also said that it had worked out new deals with borrowers for more than $300 million worth of loans, taking adjustable-rate loans and turning them into two-year or five-year interest-only loans, after which rates would adjust but, crucially, the principal would not grow.

Jim Gray, the chairman of Beach Business Bank in Manhattan Beach, said he believed that Downey was taking the right steps and should be a good candidate for federal aid.

"They've recognized what's wrong, and they're trying to fix it," he said. "They just need a little help."

In September, the U.S. Office of Thrift Supervision and Downey agreed to a consent order that required the bank to maintain a minimum core capital ratio of 7% and a minimum risk-based capital ratio of 14% at the end of every new quarter. The earnings report indicated that the company failed to meet those targets.

The bank was also ordered to present a recovery plan to the OTS this week. It provided no information on that plan in the earnings report.

--

william.heisel@latimes.com

tiffany.hsu@latimes.com

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