Downey Plummets Ahead of Weekend

The battered savings and loan's shares swooned again Friday, giving up gains during the market rally earlier this week.
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Shares of

Downey Financial

(DSL) - Get Report

plummeted as much as 25% Friday, as the battered savings and loan gave back some gains made during its three-day rise.

After hitting a 52-week low of $1.06 on Monday, the Newport Beach, Calif.-based thrift's shares climbed 266% through the close Thursday, amid a broader market rally. While the market was relatively flat Friday, Downey shares recently were down 23.2% to $2.98.

There was not much company-specific news to explain the stock's rise or fall, but Downey has been

closely scrutinized

by investors in recent months, particularly after

IndyMac Bancorp

was taken over by federal regulators last Friday. In the days leading up to IndyMac's failure,

explored the possibility the bank was going under and what that might portend for

other S&Ls


A company representative on Thursday said Downey had not yet set a date to release its second quarter financial results. A call to CFO Brian Côté on Friday was not immediately returned.

After IndyMac's failure last Friday, Downey responded after the market close on Monday with a press release stating that the regulatory capital ratio of its main subsidiary, Downey Savings & Loan Association was "enhanced by $62 million prior to the end of the second quarter." Capital was increased via a $50 million contribution from the holding company, along with a $12 million dividend paid up from the S&L's real estate subsidiary.

The press release went on to say that Downey S&L's core capital ratio, or leverage ratio, was estimated to be 7.5% as of June 30, with a risk-based capital ratio of 14.3%. These ratios were 8.43% and 15.28% as of March 31.

Banks and thrifts need to maintain leverage and risk-based capital ratios of 5% and 10% to be considered well-capitalized.

Downey went on to say that 78% of its assets were funded by deposits gathered via its branch network and that none of its deposits were originated through brokers. This had been a major concern for IndyMac, because under Federal Deposit Insurance Corp. regulations, an insured institution can't gather new deposits through brokers or renew brokered CD deposits if the institution is not well-capitalized.

Downey went further to ease concerns about its liquidity, stating it had "unused sources of liquidity in excess of $3.4 billion," including about $2.3 billion in borrowing capacity at the Federal Home Loan Bank of San Francisco.

The press release did not initially seem to carry weight with investors, as Downey's common shares slid to a low of $1.06 on Wednesday, but shares rose with the rally in financials over the next two days, closing at $3.88 Thursday. Despite Friday's swoon, shares were still 87% above levels a week earlier.

Unlike most other institutions, Downey releases monthly updates of some financial information, including lending volume, interest rate spreads, a balance sheet summary and nonperforming assets.

Excluding restructured performing loans required to be reported as nonperforming, all other nonperforming assets (including problem loans and repossessed real estate) comprised 9.77% of total assets as of May 31. Here's a summary for the past six months:

As you can see, Downey's slide in loan quality has been relentless. The interim numbers don't include capital and loan loss reserves. Loan loss reserves covered 35.39% of nonperforming loans as of March 31. More alarmingly, the ratio of problem loans to core capital and reserves was 82.33%.

While Downey's announcement of the capital enhancement was good news, we won't have a complete picture of the thrifts total exposure until the second quarter earnings results are released.

Philip W. van Doorn joined 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.