Downey Savings and Loan - Agency, Alt-A, Subprime

Update - 2008-09-07: MarketWatch reported the Office of Thrift Supervision (OTS) filed Cease and Desist Orders (C&D's) against Downey Savings & Loan, F.A. (Order Number: WE 08-12) and holding company Downey Financial Corp. (Order Number: WE 08-13) on Friday, September 5th.

"Nothing to see here folks," was the sentiment of Downey officials echoed in news accounts. In their press release, Downey's Board Chairman Michael Bozarth waived the C&D's off as mere formality:

"We have been working closely with our regulators to aggressively address the challenges Downey has been facing in this unprecedented financial environment and are pleased to have reached agreement on a formal plan that addresses the OTS' concerns," said Michael Bozarth, Downey's Chairman of the Board. "The Orders reflect a number of measures that Downey has already undertaken and, in some cases, is close to completing. Having reached agreement on these Orders, and having successfully raised a significant amount of new capital, Downey has made substantial progress."

Although Downey touts this as addressing "concerns," the OTS does not act unless action is necessary, and regardless of pleadings of "substantial progress" this merely suggests Downey's inability to completely and immediately comply with their marching orders. The OTS has not been known to deal in "mere formalities."

The Orange County Register reported that "Thomas Prince, interim Chief Executive Officer of Downey, downplayed the regulatory actions today, saying his company has been working with regulators and taking needed steps." -- no doubt, after soft-peddling it in their last quarterly report. An article in LA Times reported:

"In July, the OTS said Downey had "engaged in unsafe and unsound practices" that had weakened its asset quality, earnings and future capital.

That same month, Maurice McAlister, the company's chairman and co-founder, stepped down. McAlister had run the thrift for half a century, for part of that time with Chief Executive Daniel D. Rosenthal, his former son-in-law. The company also said it was looking for new capital or a sale.

"This is probably what led to McAlister's departure -- it was a consequence of that examination by the OTS," said Bert Ely, a veteran banking consultant. "So what's coming out now is really what's been in the pipeline.""

Downey Savings & Loan Association is subject to the following conditions under the Cease & Desist Order as reported in their 8-K filing:

• Meet and maintain a minimum Tier 1 Core Capital ratio of 7% and a minimum Total Risk-Based Capital ratio of 14% at each quarter-end beginning September 30, 2008;
• Submit to the OTS an updated Capital Augmentation and Strategy Plan addressing how the Bank will meet and maintain the foregoing capital ratios and that provides for the raising of new equity and a capital infusion by no later than December 31, 2008, together with an alternative strategy to meet and maintain the Bank's capital and ensure its safe and sound operation if the plan to raise additional capital is not successful;
• Submit for OTS approval within prescribed time periods (i) a comprehensive classified asset reduction plan, (ii) a real estate owned disposition plan, (iii) an updated business plan containing strategies for a reduction in concentration of payment option adjustable rate mortgage and stated income loans and (iv) a plan to strengthen executive management;
• notify, or in certain cases receive the permission of, the OTS prior to (i) increasing its total assets in any quarter in excess of an amount equal to net interest credited on deposits during the quarter; (ii) making certain changes to its directors or senior executive officers; (iii) entering into, renewing, extending or revising any contractual arrangement related to compensation or benefits with any director or senior executive officer of the Bank; (iv) making any golden parachute or prohibited indemnification payments; (v) paying dividends or making other capital distributions; and (vi) entering into certain transactions with affiliates;
• Refrain from any unsafe and unsound practices regarding lending and from resuming payment option adjustable rate mortgage or stated income lending programs; and
• Comply with the OTS' most recent report of examination with respect to the Bank.

NOTE: DSL's ratios as of June 30, 2008 for core capital and total risk-based capital were 7.57% and 13.23% respectively.

The origination of Stated-Income loans and Pay Option ARMs had previously been eliminated, and Downey has raised $109 million in capital through the sale of certain assets so far in its efforts to cooperate with regulators.

Update - 2008-08-13: Downey's shares held today, closing at $1.72 after Market Watch reported yesterday's drop of 18% from a Monday close at $2.10. Bloomberg reported "depositor withdrawals were 'elevated'." The article ends with this correlative statement:

"IndyMac Bancorp Inc. was seized by U.S. regulators last month following a run by depositors."

It's not a novel idea that there exists some coincidence, given the similarities pointed out by blogger Anthony Freed in his article "Downey Under New Restrictions."

"It certainly seems that the Feds are putting regulatory pressure on Downey where they were not inclined to intervene at Indymac, even when Indymac's liquidity situation was much more grim than Downey's is currently. Are we seeing a new and tougher Federal Regulatory presence beginning to emerge? Me thinks I hear the rumblings of a long sleeping giant."

To read the entire commentary, visit the forum thread on Downey Financial here.

Update - 2008-08-11: After seeing this section from Downey Savings and Loan's 10-Q filing today for the second quarter of 2008, we have to wonder if they are operating under an OTS "Memorandum of Understanding":

"In light of the current operating environment and Downey's recent quarterly losses, the Holding Company and the Bank have been working closely with the Bank's federal banking regulators. In that regard, the OTS, the Bank's principal regulator, has also imposed the following limitations on the Bank: the Bank may not pay dividends to the Holding Company without prior OTS approval; the Bank may not increase its assets during any quarter in excess of an amount equal to net interest credited on deposit liabilities without prior OTS approval; the Bank must provide prior notice to the OTS regarding any additions or changes to directors or senior executive officers (or changes in the responsibilities of senior executive officers); the Bank may not pay certain kinds of severance and other forms of compensation without regulatory approval; the Bank may not enter into, renew, extend or revise any contract related to compensation or benefits with any director or senior executive officer without prior regulatory approval; and the Bank must provide prior notice to the OTS (and not receive any objection) before engaging in transactions with any affiliate or subsidiary. In addition, the Bank is subject to higher regulatory assessments and FDIC deposit insurance premiums than those prevailing in prior periods."

Update - 2008-07-14: Since our last update, shares in Downey Savings & Loan (DSL) have fallen to a new low, closing today at $1.28 per share.

An article today on CNBC points to more dire circumstances:

Chris Thornberg at Beacon Economics says, "IndyMac was the first major institution that wasn't too big to fail." He says... hundreds, maybe thousands, of smaller, regional banks will now realize they have no savior.

Richard Bove at Ladenburg Thalmann has a different take... on who may be next."

Bove's analysis, according to that article, looks at two ratios, both of which do not paint a pretty picture for Downey Financial Corp., the parent holding company for Downey Savings & Loan. First of those looks at non-performing assets to total assets. MarketWatch reports:

"Downey Financial said Sunday that its nonperforming assets hit 14.33% of its total assets in May, up from 10.75% at the end of February. A year ago, Downey's nonperforming assets were 1.3%."

Bove's second ratio divides non-performing assets by reserves plus common equity. "A ratio about 40 percent is the danger zone." We do not have direct access to the report, but Downey's on that "danger" list too, according to the same article.

Said one poster on the Yahoo!Finance message board for DSL... "DSL meet IMB."

Update - 2008-06-13: In their press release of "Thirteen Month Selected Financial Data" today, Downey Financial Corp. reports total non-performing assets (NPA's) have hit a new high of 14.3%. The percentage has been steadily increasing every month, most sharply since November of 2007 when it began jumping up by as much 2% each month.

The Orange County Business Journal said "Concerns about mortgages at Downey have driven down the company's shares some 90% in the past year." Reuters noted NPA's amounted to "one seventh" of Downey's total assets, a "nine-fold rise in bad loans for May from a year ago." Assets were reported at $12.78 billion, also down from $15 billion in May of 2007.

Original Listing - 2008-05-31: We've been watching Downey Savings and Loan slide downhill for some time now. In recent news, a rash of shareholder class action suits have been filed against parent holding company Downey Financial Corporation:

• Stull, Stull & Brody Announces Class Action on Behalf of Shareholders of Downey Financial Corporation
• Holzer Holzer & Fistel, LLC Announces That a Shareholder Class Action Has Been Filed Against Downey Financial Corporation
• Charles H. Johnson & Associates Announces Filing of Securities Class Action Against Downey Financial Corporation
• Brower Piven Encourages Investors of Downey Financial Corp. to Inquire About Lead Plaintiff Position in Securities Fraud Class Action Lawsuit
• Federman & Sherwood Announces That a Securities Class Action Lawsuit Has Been Filed Against Downey Financial Corp.
• Coughlin Stoia Geller Rudman & Robbins LLP Files Class Action Suit against Downey Financial Corp.
• Schatz Nobel Izard P.C. Announces Class Action Lawsuit Against Downey Financial Corp.
• Shareholder Class Action Filed Against Downey Financial Corp. by the Law Firm of Schiffrin Barroway Topaz & Kessler, LLP

We anticipate most these will be consolidated. You can view the original complaint (by Coughlin et al) here.

Yet another class action was filed on 2008-05-28 - this on behalf of loan officers employed by subsidiary Downey Savings and Loan Association, F.A. based in Newport Beach, CA for alleged labor law violations. As if that weren't enough, there was also a civil action alleging violations of TILA and RESPA filed the same date.

It's only the latest installment in Downey's pain. Comments have been coming in:

"Wholesale closed most of their Ops Centers at the first of the year. All the AE's in Sacramento quit months ago...They have stopped updating their web site the stock has plummeted etc. Seems like Wholesale is going to have to be shut if the bank is to survive."

"With their concentration in So California and their exposure to tons of adjustable rate mortgages, I know they are in trouble... "

"Downey Financial just laid off their wholesale branch in AZ..."

Brokers we've spoken to say wholesale has been discontinued but this may not be accurate. We also saw this:

"At almost 10%, Downey Financial's nonperforming assets hits an all time high for an S&L! S**t has to hit the fan... soon. Most likely a buy-out. But offering loan restructuring WITHOUT an appraisal (most loans are in Southern California) or credit check, seems idiotic."

From the Orange County Register: Bad assets climb at Downey Financial:

"Although the refinancing program has been offered to folks who are current on their mortgage, Downey's auditor KPMG thought impacted loans should be classified as nonperforming assets since Downey did not reunderwrite the loans with new appraisals, credit reports, etc."

As of this writing, their stock is down below $7 a share from its 52-wk high of $74.11. Ninety percent? Yes, that spells trouble. We'll continue watching...closely.

Send us any info (with links) you come across. A thread for Downey has been established on our Discussion Forums. Feel free to comment.