All Eyes on Downey Financial

What’s the future for troubled Downey Financial Corp. (DSL)? This week, investors have been flooded with a stream of bad news around the California-based option ARM specialist. On Monday, the company’s quarterly filing with the Securities and Exchange Commission disclosed that the Office of Thrift Supervision, its main regulator, had imposed several restrictions on the bank since its Q2 earnings were reported on July 24. The bank also said that it saw “elevated” levels of deposit withdrawals after reporting a $218.9 million second-quarter net loss — but it should be noted that the bank stressed that net deposit inflows have since returned. Non-performing assets at Downey increased during the second quarter by $395 million to $1.96 billion, and now represent a stunning 15.5 percent of total assets, compared with 7.77 percent at year-end 2007 and 1.53 a year ago. Speculation circled this week that the bank was subject to a OTS Cease & Desist order, although the SEC filing only mentioned “restricted activities” — including a limitation on dividend payments, and a cap on asset growth. Downey also can’t renew debt facilities or borrow more money without OTS approval, nor can it pay certain compensation and severance without approval from its regulator, according to the filing. Officials at the OTS and Downey have declined to comment on the specifics surrounding the bank’s regulatory outlook. Concerns lead to S&P downgrade On Thursday morning, market participants got even more news to digest, as Standard & Poor’s Rating Services said it had downgraded the bank’s counterparty credit rating to B+/C from a prior rating at BB+/B. “We are concerned that depositors in Downey’s footprint have a heightened sensitivity to potential bank failures after recent experience and publicity, which increases the possibility that Downey could experience further material deposit outflows,” said S&P analyst Robert Hoban. “If that were to happen, it could overwhelm Downey’s liquidity and/or trigger an adverse regulatory action.” By “Downey’s footprint,” Hoban is referring to Southern California; recently-failed IndyMac Bank operates in the same geographic area. S&P also said that continued growth in non-performing assets, and another quarter like the second quarter, would likely threaten the bank’s “well capitalized” designation and could “overwhelm” Downey’s existing finances. Disclosure: The author held no positions in DSL when story was published; indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.