Downey's Cushion Not So Soft After All

Even with such terrible loan quality, Downey's relatively high level of capital has enabled it to maintain adequate loan loss reserves. The company's risk-based capital ratio was 15.04% as of March 31, while it needs to maintain a ratio of 10% to be considered well capitalized under regulatory guidelines.

Still, the question is, how long can this go on? If Downey's nonperforming loans were to stabilize at this level, it would have sufficient reserves to avoid taking significant further net losses and preserve its capital. So far, its additions to loan loss reserves over the past few quarters have greatly outweighed the company's net loan charge-offs.

Even Downey's strong capital position could be threatened if the company reports similar large increases in problem loans over the next two quarters. Just in the first quarter of 2008, the company's risk-based capital ratio dropped from 18.70% to 15.04%. While it's still a high level of capital, Downey's annualized return on equity of negative 76.96%, shows that several quarters of similar performance will force the company to raise capital, diluting current shareholders.

Downey also announced that while it would pay its usual 12-cent dividend for the first quarter, future dividends would be suspended in order to preserve capital.