Following our chin-wag rearmost week of resource eminence at the , TheStreet.com Ratings took a closer glance at Downey Savings & Loan, a $13.4 billion sanatorium with headquarters in Newport Beach, Calif., and the critical subsidiary of Downey Financial Corp. DSL. Downey Financial has been a lot pilloried in the rumour during the real-estate moment because of its centre on option-payment mortgages.
Shareholders bygone 70% of their bazaar value over the background year, and 39% year to date, as of the retail close on April 7. With the extraction selling at a price-to-book relationship of less than 0.4, some major investors reckon with the holding company a bargain.
In a March 11 SEC filing, Citadel Investment Group reported it had infatuated a 4.98% wager in the holding company. Legg Mason Capital Management (managed by Legg Mason Inc. LM ) reported a chain of cruelly 7% as of Dec. 31. Downey Savings reported nonperforming assets comprising 7.38% of downright assets as of Dec. 31, a unspeakable development from 2.21% the former quarter.
But as we reported when we discussed IndyMac Bank (held by IndyMac Bancorp IMB ), things can front very numerous when you con holding corporation filings. While Downey's correlation of nonperforming assets was the highest in the midst the largest 100 banks and S&Ls, it included performing mortgages that had been modified to forward the burdens of some borrowers and quieten the institution's acclaim risk. Option-Payment ARMs The modified loans were option-payment adjustable-rate mortgages with opposing amortization features. A borrower with an option-payment credit has at least two choices for a advance pay each month.
The highest recourse payment is the fully amortized payment, which includes the enrol accrued in the quondam month and a apportionment of the principal. The lowest selection payment almost always includes no head and only a chunk of the accrued interest. If the borrower makes the highest privilege payment each month, the honcho up declines, just relish it does with a ordinary mortgage loan. If the borrower makes the lowest alternative payment, the accommodation equilibrium increases.
This is the "negative amortization." While the payment chance can be a practical trend for a month or two, it can also be a while bomb. Combine an increasing allowance balance with a declining severely price and maybe even a second mortgage, and you have possible for serious trouble. According to the holding company's 2007 10-K report, Downey had $7.5 billion in way out ARMs in its portfolio at year-end, with about 5% of the match representing antipathetic amortization.
Anyway, $401 million in option-payment mortgages that Downey Savings modified as voice of its purchaser retention program were required by accounting rules to be reported as nonaccrual loans, even though the borrowers had not missed payments. This was because the loans were modified at more favorable terms for the borrowers. The loans will beggary to carry on up to date for six months after modification to be considered "performing" again. If we recalculate Downey's benefit worth ratios excluding the $401 million, we come up with nonperforming assets comprising 4.39% of amount to assets as of Dec. 31. Loan-loss reserves covered a all right 62.54% of nonperforming loans.
The proportion of nonperforming loans to nucleus splendid and reserves was 28.65%. Downey Savings also boasted rather serious topping ratios, in that it reported a ultimate defeat of $51 million during 2007. At year-end, the institution's leverage correspondence was 10.18%, and its risk-based wherewithal ratio was 19.35%. These ratios are much higher than the 5% and 10% needed to be considered well-capitalized under regulatory guidelines.
Downey's mesh-work ruin for 2007 mainly reflected eminent provisions for loan-loss reserves. These totaled $310 million for the year, staying far in front of the institution's $25 million in earnings loan charge-offs. More Trouble Ahead Downey Financial Corp. provides monthly updates between its every ninety days reports.
Looking at is unaudited interim numbers for Feb. 29, nonperforming assets (again, not including the performing modified mortgages) comprised 6.63% of utter assets, a fierce snowball in only two months. While the current failing in tempt rates will outfit stand-in to some of Downey's borrowers whose rates reset this year, the uninterrupted fall off in almshouse prices is having a more abrupt effect.
Downey's loan underwriting has been somewhat aggressive. According to the holding company's 10-K report, 82% of its residential loans held for investment as of Dec. 31 were underwritten based on the borrower's "stated income," with the borrower's assets being verified. Another 7% of the portfolio was underwritten with neither the borrower's gain nor assets being verified.
In a slowing economy, borrowers who were unwilling or powerless to verify their proceeds could be experiencing punitive declines in their income. Another chance is that the assets Downey verified to adjudge borrowers' creditworthiness may have declined significantly in value, along with the value of the homes securing the mortgages.
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