Downey's Cushion Not So Soft After All

Downey Financial(DSL Quote) may soon join the growing list of financial institutions seeking an additional capital cushion against souring loans.

Downey, the holding company for Downey Savings & Loan, on Monday reported a $247.7 million first-quarter loss fueled by another huge increase in bad loans. Moody's on Tuesday downgraded the holding company's senior debt from Baa2 to Ba1, with a negative outlook.

In another recent piece, I noted Downey's loan quality wasn't quite as bad as it appeared on the surface, since performing loans that were restructured to benefit borrowers were required by accounting rules to be reported as problem loans.

I also pointed out that Downey's capital ratios were quite high, probably enabling it to ride out the storm, and avoid joining the list of banks raising capital and diluting shareholders, including National City(NCC Quote), Wachovia(WB Quote) and Washington Mutual (WM Quote), as well as ongoing capital raises by Citigroup(C Quote) and Wednesday's $24.9 billion bomb from Royal Bank of Scotland (RBS Quote).

Based on the partial set of first quarter numbers for the holding company available at this point, Downey's loan quality and capital ratios paint a more grim picture compared to last quarter. Once again, we are excluding restructured performing loans:

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Downey's nonperforming assets shot up to 7.41% as of March 31. The net loss of $247.7 million mainly resulted from a $236.9 million provision for loan loss reserves. The loss also reflected a significant decline in interest income because of a high level of problem loans.

Loan loss reserves covered 69.7% of nonperforming loans, again excluding restructured performing mortgages. That's a stronger coverage ratio than the previous quarter, despite the 49% increase in nonperforming loans.