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Downey's Cushion Not So Soft After All

04/25/08 - 10:18 AM EDT

Philip van Doorn

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.




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Philip W. van Doorn joined TheStreet.com Ratings., Inc., in February 2007. He is the senior analyst responsible for assigning financial strength ratings to banks and savings and loan institutions. He also comments on industry and regulatory trends. Mr. van Doorn has fifteen years experience, having served as a loan operations officer at Riverside National Bank in Fort Pierce, Florida, and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a Bachelor of Science in business administration from Long Island University.

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