Downey's Aversion to Home Equity, Construction Lending: Key to Its Survival

This article has been deleted at the author's request.

Comments

[silk:]

While this article doesn't focus on all of Downey's problem loans, I agree that at $5 share the stock has gone too far and certainly too fast. If Downey goes under, it will not be the first and many others will fail before they do.

2008 Jun 11 07:51 AM

[Philip Gvinter:]

While this is an excellent analysis of Downey's artificially inflated book value this article has absolutely no connection with the reality of Downey's insolvent financial situation. A majority of Downey's "assets" are Pay Option ARMs in the California market. While these loans are currently performing they continue to do so only during the initial period where negative amortization is available as a payment option for the borrowers. The majority of this loan portfolio was originated using Stated Income or an even lower level of documentation. The majority of the loan portfolio was also originated with Loan-to-Value rations in the 70% to 80% range. These are actually the riskiest loans possible as there is no PMI or other credit enhancement present in the loan. The structure of DSL's Option ARMs allow borrowers to pay the minimum neg-am payment up until the loan balance reaches 115% of the original loan. This would mean that a loan originated in 2006 on a $500k house for $400k would allow the borrower to pay minimum payments until the borrower chose to differ $60k in interest payments. At this point the minimum payment will go away and the borrower will be forced to make fully amortizing payments on the remaining loan term (let's say 27 years on a 30year loan and 37 on a 40 year loan.) This means that a house originally valued at $500k, which after the recent price correction is now worth approximately $450 has a loan balance of $460k. Add to this $50k in foreclosure costs and another 10% to 30% discount to sell the house and suddenly DSL is recovering somewhere around $250k to $350k on it's "asset" of $460k.
Using fundamental analysis which looks only at book value while ignoring the necessity of due diligence on the booked assets which gets investors into DEEP trouble. It is also this line of thinking combined with a reliance on a chain of third parties, each of which absolves themselves of due diligence responsibility (brokers, rating agencies, etc.) which allowed companies like DSL to underwrite and sell garbage sub-prime, ALT-A and other low quality debt which helped create the current financial crisis. While I empathize with the author on the losses incurred by their long DSL position I also advise him and anyone else to cut the losses here and walk away as DSL will follow IMB, BKUNA, IMH, AHM, NFI, NEW and numerous others to a share price of somewhere between $0 and $2.

2008 Jun 11 09:37 AM

[dashingdwl:]

it's BK guys. End of discussion.

2008 Jun 11 10:53 AM

[Timbo:]

Have you been to LA? When the pay options go bad it will be all over for Downey. Sad but true. It will be "bought" for less than $1 per share. Deposits can fly out the front door faster that realtors can say now is the best time to buy.

2008 Jun 11 11:42 AM

[viewfromnyc:]

Disclosure my fund is short FED, FirstFed CA

Just a few comments on DSL. NPAs are over 13%. LTVs listed are at orgination, so the portfolio would have a much higher current LTV ratio if the V portion was marked to market. Therefore loss severity is poised to increase. Run some scenarios at different severity ratios and determine if the current provision for loan loss is adequate. If not, which I don't think it is, you need to make a reduction in book value. Provision probably needs to more than double to just to cover current NPAs, then make some provision for future deliquencies. There goes some more book value. Then there is the farce of negative amortization. Subtract that accumlated neg. am. interest of $375 million from book value (not to double count with the general provision for loan loss) put this in the specific loan provision bucket rather than the general provision. As soon as these loans recast to fully amortizing, the borrower who couldn't pay even the interest only portion certainly won't be able to cover interest plus amortization of principle. The company is never going to collect that inerest which has been added to book value through earnings. These two adjustments alone get you to a current mid twenties book value. Properly reserved then the book value is is the mid to high teens. Then apply a discount and maybe the stock looks cheap at $4. The problem is pretty soon you run out of regulatory capital and there goes the only "asset" the company has (the deposit base) as the FDIC gets another bank to take over the deposit liability. Finally if you really think this company could survive, look at the on going business, no bank is going to be able to originate exotic products for the foreseeable future so normalized origination volumes will never recover (forget about trough origination volumes). As the performing loans run off so will interest income decline so even if the company could survive a significant discount to book value would be warranted. Cramer missed the complete change in the business model of these formerly conservative lenders, which is why he hasn't said a word about them.

2008 Jun 11 11:42 AM

[The Jackal:]

If CNBC’s Jim Cramer recommended DSL it is a short. This stock is going to ZERO. I know a few employees at DSL and the moral is at an all time low and going lower (just like the stock).

2008 Jun 11 12:17 PM

[kurt walter:]

Isn't DSL the king of pay option ARM loans. Those are exotic loans for many people that couldn't afford to buy real estate.

2008 Jun 11 12:52 PM

[Snowytrail:]

Kurt, you have it exactly right. Downey's current "business model", if you can call it that, is that of landlord for approx 15,000 tenants with below market month to month leases. The tenants have little to no equity and in many cases put nothing down. The tenants can stop paying for 4-5 months before they can be evicted and when they do leave, the owner(Downey) has great difficulty reselling the lower value assets and will now have to pay for any maintenance and property taxes while holding the REO. Not a business I want to invest in.

2008 Jun 11 09:13 PM

[anastos:]

We're still talking about DSL? This thing had a fork stuck in it months ago....I wouldn't get near it with your money and someone else trading it.

2008 Jun 17 02:54 PM

[chief:]

Mr. Pelham wrote a somewhat glowing report on DSL's problems. Is he not an employee of DSL????

2008 Jul 20 07:02 PM