As the financial and banking industry prepares for President Barack Obama's formal proposal of regulatory overhaul, a report issued this week highlights one federal regulator's actions preceding the costly failure of Downey Savings and Loan. The Office of Thrift Supervision (OTS) regularly monitored Downey, noting problems but failing to issue anything more than an informal enforcement action, according to a government watchdog. The Office of Inspector General (OIG) for the US Treasury Department this week published a report on the failure of Downey, which the OTS closed in November and which so far has cost the Federal Deposit Insurance Corp.'s insurance fund $1.4bn. OIG's report concludes the Newport Beach-based thrift had high concentrations of pay-option adjustable-rate mortgages, low-doc and subprime loans among its single-family mortgages. Pay-option ARMs accounted for 91% of Downey's single-family loans by year-end 2005. "The downturn in the California real estate market that started in 2006 exposed the risk in these loans and Downey suffered large losses and erosion of capital," the report says. Single-family residential loans made up 86% of Downey's assets in September 2008 and by then, 20% of its borrowers were more than 30 days delinquent. This concentration of risk combined with inadequate risk monitoring, a high management turnover rate and "unresponsiveness to OTS recommendations" -- including instances where management often challenged OTS opinions -- ultimately led to the thrift's downfall, OIG found. The report notes OTS regularly examined the thrift but fell short of its own written guidance in issuing only an informal -- rather than formal -- enforcement act in 2006 in response to Downey's trouble. OIG reserved some mild language concluding OTS should more closely review thrifts in the future. Write to Diana Golobay.