In the Crosshairs: Downey Financial

Downey Financial Corp. released its latest financial update today, and the results weren’t pretty: non-performing assets increased 20 percent, or $105.4 million, in just one month between October and November, according to a filing with the Securities and Exchange Commission.

NPLs now represent 3.65 percent of total assets, up from a mere 0.55 percent one year ago.

The rise in nonperforming loans has been particularly stunning at Downey when you consider that the pay-option ARM specialist was among the most conservative in the space when it came to underwriting and loan-to-value criteria — the problem here, of course, is seconds.

Herb Greenberg at MarketWatch notes that this trend might prove problematic at WaMu, which has already been battered by its subprime mortgage exposure:

If Downey is boosting non-performing loans (mostly Option ARMs) by such a large amount, on a rapidly rising rate of increase — and if Downey was considered among the best underwriters — other lenders with high Option Arm exposure become vulnerable. At WaMu, for example, 27% (the biggest chunk behind home-equity lines) of loans held for investment were Option ARMs. Other big Option ARM lenders include Wachovia Bank, FirstFed Financial, BankUnited Financial and Guaranty Financial Group, which is being spun off from Temple-Inland.

Looks like the rest of the media is finally catching on to something I’ve been harping in this space for awhile; option ARMs are going to be a big problem, especially in California. Highly-leveraged borrowers could end up simply walking away from their homes.

Numerous industry sources I’ve spoken to are already or are planning to bolster their servicing and default operations in preparation for just this sort of outcome, and some have said they expect — at least in California — that the option ARM problem could be a bigger concern for neighborhood stability given the credit profiles of the affected borrowers.

In a nutshell: we’re not talking about subprime borrowers here, and we’re not talking about the neighborhoods most typically affected by high foreclosure activity.