Downey Raises the Red Flag

It’s been called the “kiss of death” by more than a few auditors and accountants I know, not to mention investors who have spent any amount of time investing in financials. It’s the dreaded “going-concern” warning — no bank ever wants to put such a phrase into its quarterly report, and in fact will rarely ever mention it in the actual earnings release, either. Such dirty details are often relegated to the bowels of a 10-Q, where the hope is that the damage of disclosure will be somehow more limited. The latest bank to sully its quarterly filing with the Securities and Exchange Commission by including a “going concern” warning is Newport Beach, Calif.-based Downey Financial Corp. (DSL), which has long been in the cross hairs of industry participants given its headlong run into pay-option ARM mortgages during the recent housing boom. HousingWire ran coverage in late October that looked at the potential future for the bank, and our assessment was less-than-positive; a few readers suggested we were being overly harsh. Maybe we weren’t harsh enough: Downey’s own filing this week cites a “significant risk that the bank will not be able to raise sufficient additional capital to ensure compliance with the capital requirements of the bank consent order by yearend,” and said that such a failure would likely put the bank into federal receivership. Read the full SEC filing. Of the bank’s $12.8 billion in total assets, $5.7 billion were in the form of option ARMs held in portfolio at the end of the third quarter; deposits totaled just $9.6 billion at quarter end, down $1 billion from one year ago, as depositors withdrew funds over concerns about the bank’s future. Like other lenders, Downey has stopped making option-ARM loans and is looking for new investors or a buyer; it also closed its wholesale lending division and laid off 200 employees as it looks to consolidate and refocus its operations. 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 percent and a minimum risk-based capital ratio of 14 percent at the end of every new quarter. It exceeded both ratios at the end of the quarter, according to the earnings statement. Without intervention, the bank won’t be so lucky by the end of Q4. “Based on the bank’s current and projected levels of capital, the bank anticipates that it will not be able to satisfy” regulator-mandated capital requirements without a cash infusion, the company said in the filing. Not surprisingly, investors literally fled the bank in Tuesday’s trading session, punishing shares to the tune of a 69 percent drop; shares in the ailing bank closed at just $.45. There has been, so far, no word on whether depositors were making the same decision. Write to Paul Jackson at Disclosure: The author held no relevant investment positions when this 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.

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