Downey Financial

(DSL) - Get Report

dropped 4% in early trading after the savings and loan warned that rising loan losses will lead to a loss for the third quarter.

The Newport Beach, Calif.-based bank said it expects to post an operating loss of $23 million, or 84 cents a share. Analysts had expected Downey to make $1.08 a share in the third quarter, according to Thomson Financial.

During the third quarter, the bank took an $82 million provision for credit losses. The provision will increase its allowance for loan losses to $144 million, or 1.22% of loans held for investment, it said.

Downey also took a $9 million writedown on certain real estate held for development to reflect "declines in the value of single family home lots in which the company is a joint venture partner," it added.

"We are clearly disappointed with our third-quarter results," said Daniel Rosenthal, Downey's president and CEO. "The continued weakening and uncertainty relative to the housing market, coupled with third-quarter disruption in the secondary mortgage markets, unfavorably impacted our borrowers and the value of their loan collateral. This has been particularly true in certain geographic areas such as the greater Sacramento and Stockton areas of Northern California and San Diego county. As a result, single family loan delinquencies, as well as losses from foreclosures, rose significantly during the third quarter and led to this quarter's large increase to the allowance for losses."

Downey operates 168 branches in California and Arizona.

Downey joins big banks including


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Sovereign Bancorp

( SOV) in taking big hits tied to the downturn in the housing market as well as this summer's credit crunch.

Rosenthal added that the bank has further tightened its lending guidelines, implemented a loan modification group to work with borrowers and provided resources to dispose of homes acquired through foreclosure on a timely basis.

"Downey remains well positioned to continue funding quality loans because of our strong capital position and stable source of funds from our retail branch franchise," he said.

Shares were down $2.38 to $56.99.