Option ARM specialist Downey Financial Corp. (DSL) said after market close on Monday that it lost $247.7 million -- $8.89 per share -- during the first quarter of 2008, as the volume of sour loans on its books continued to skyrocket upward. The first quarter loss compares to earnings of $42.9 million, or $1.54 per share, one year earlier. Not surprisingly, Downey said it would suspend future dividend payments as chairman Maurice McAlister said the Newport Beach, Calif.-based lender would look to "preserve capital during this difficult operating environment." We can already hear investors asking: so, when's the capital raise? Downey as of yet hasn't said it will seek to raise capital, but sources suggested to us that it may be a matter of time relative to the losses piling up, thanks to a heavy concentration of option ARMs in California. Downey president Rick McGill noted that the lender has been scaling back on option ARM activity as quickly as possible, amid even more quickly deteriorating conditions in key local housing markets across the state. "The improved quality of our current loan portfolio also is reflected by the significant decline in our concentration of Option ARM loans," he said. "Our option ARM loans declined by $3.1 billion from a year ago and currently represent 65 percent of our single family loans, compared to 81 percent a year ago." That being said, 65 percent of a $10.7 billion residential mortgage portfolio is still plenty of exposure left to burn. The lender said it provisioned $236.9 million for credit losses, up slightly from $236.3 one year ago -- leaving it with $546.7 million reserved for loan losses, net of $37 million in quarterly charge-offs, against a looming $1.562 billion in non-performing assets on its books. With reserves just 35 percent of NPAs, and NPAs mostly of the upside-down borrower, negative-equity type, it's probably not surprising to see why most analysts think a significant jump in credit loss provisioning lies in the company's future. Total NPAs now represent 11.9 percent of total assets, Downey said; a forced inclusion of troubled debt restructuring activity boosted reported NPAs at the end of the quarter by 4.49 percent.
Downey NPAs, March 2008
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Downey has been aggressively putting option ARM borrowers into fixed-rate loans lower than their original option ARM rate without going through formal underwriting, as it looks to stay ahead of declining markets in many California locales; it said it modified $280 million worth of loans as part of this program during the first quarter of 2008. The graph to the right illustrates the rise in NPAs and break down troubled debt restructuring activity -- and it's clear that NPAs are going up regardless of the measure used. Downey said it was seeing losses accelerate in key areas of the Golden State, including: Sacramento, Stockton, Modesto and Contra Costa areas of Northern California, the Inland Empire and San Diego County. Disclosure: The author held no positions in DSL when this story was originally published. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.