Downey Posts Terrible 2Q - As Predicted

The Wall Street Journal is finally getting it:

Most of the attention surrounding sub-prime and high-risk lending in recent months has focused on lower-income or high-risk borrowers who didn't realize they were taking loans that would be difficult to repay. But the Village of Penland project shows how the go-go climate of a real-estate boom, combined with an environment of easy borrowing, also infected well-off borrowers with healthy credit records -- many of whom now say they should have realized the deals were too good to be true.

Watch this video of Cramer "discussing" Downey (DSL) on CNBC. Look how unhinged he is: "DON'T focus on the darn quarter!"

He's been making the ludicrous suggestion that WaMu (WM) should buy DSL for $100 per share. Cramer's thesis is that Downey is cheap, in a growth area, and has no loan loss problems. If you believe that, I have shares of Downey to sell you.

Downey is cheap if you believe that they have a prayer of collecting on their loans. Negative amortization balances were up to 377M this quarter, which is 25.8% of stockholders equity (up from 320M and 23% in January). Negative amortization is a debtor's death spiral.

Its net income was 75.6M in 2007 YTD, and negative amortization balances increased by 57M. Fully, 75% of its net income in 2007 has been non-cash negative amortization.

To believe that DSL is a buy, you have to believe that negatively amortizing borrowers are using it as a tool to prudently manage their household balance sheets. You have to believe they are not making the minimum payments just to stave off foreclosure a little longer.

Imagine that you bought a McMansion in California, in a far-flung suburb away from cool sea breezes. You paid $820,000 for it in 2006. It's been on the market since April this year, and there are no takers at $689,000. Your HOA, and Mello-Roos are $1200 per month. This is a true story.

Downey is not in a "growth area," either. The types of loans they specialize in (Option ARMs) don't make sense for borrowers or lenders anymore. Especially when real estate prices are declining.

And, it most certainly is experiencing a problem with loan losses. Its Real Estate Owned (foreclosed houses) increased by 12.7M from Q1 to Q2 - a low eight figure amount, just as I predicted on this blog. It cost them $948,000 just in the second quarter to manage those houses.

[I wrote the above words over the weekend, and by the time I'm posting this, the market has started to catch up with Downey. At this point, I'll refer you to the post my friend Amit wrote about Downey.]

Comments

[Tony Rand:]

DSL's problems should be of no surprise to anyone. Back in the Q4 of 2006, it was estimated by several analysts that DSL's liquidity would fall short of maintaining reserve requirements. If a portfolio lender has such a high concentration of negative amortizing loans on its books, how can it (and its shareholders) expect to fully survive a market correction like we've never seen before? Greed and poor disclosures, when added to the current market conditions will likely make DSL attractive to WM, however, they should take a taste of DSL first -- they might find them to be too bitter.

2007 Jul 25 11:25 AM