Short-sellers look like they made the right call on Downey

"Short sellers" have been betting heavily on the demise of Newport Beach-based mortgage lender Downey Financial Corp. It’s looking more and more like they had this one right.

With the thrift’s announcement this morning of another huge quarterly loss -- $218.9 million, or $7.86 a share -– Downey’s shares have plunged again. They were down 72 cents, or 27%, to $2.01 at about 11:30 a.m. PDT.

That’s still above the recent closing low of $1.28 on July 14. But Downey’s management shakeup today, and its announcement that it is "exploring a broad range of strategic alternatives" for the business, clearly have some shareholders figuring they may wind up with nothing, a la IndyMac Bancorp shareholders.

Downey’s non-performing assets (bad loans) jumped by $395 million in the quarter ended June 30, to $1.96 billion. That is 15.5% of its total assets, double the percentage at year’s end.

The total of loans that were 90 days or more past due was $796 million at June 30, up from $576 million at March 31 and $314 million at year’s end.

"They have a portfolio that is literally falling apart," said Paul Miller, an analyst at Friedman Billings Ramsey & Co.

Meanwhile, the bank is bleeding deposits as some customers vote with their feet. Total deposits were $9.88 billion at June 30, down $364 milllion from three months earlier and down $616 million since year's end.

Short sellers -- traders who borrow stock and sell it, betting the price will decline -- have helped to hammer Downey's shares in the last two months. The number of shorted shares reached 15.9 million at June 30, more than half the company’s total outstanding.

Downey may well have been a victim of "naked" short selling, the strategy the Securities and Exchange Commission cracked down on beginning last week.

But before vilifying the short sellers, it’s worth remembering: They weren’t the ones who made the mortgage loans that now are dragging Downey under the waves.

Comments

[Kat]

We couldn't stomach the Downey slide and yanked our $200K + this week taking penalties.....too many negative articles and too many pictures and horror stories ala Indymac. The bank manager tried to get us to leave the money, but from the looks of the branchworkers you can tell they are worried...not much smiling going on. I ask the manager if she'd had many people like us come in and withdraw and reluctantly she said there had been quite a few .....It feels so much better to watch from the sidelines.

[Edward Tamayo]

I think the name says it all!

[Jake]

Yes, it is correct that short sellers did not make the mortgage loans, but can you please explain to me how the short sellers benefited the economy? Is it their role to grind these banks to the pulp until nothing is left? What value did they create?

[Caleb Matar]

I would say with the FDIC suddenly making noises about censoring people who make their lives difficult by talking about banks with negative financials:

http://www.bizjournals.com/losangeles/stories/2008/07/21/daily15.html

And with their newly defined abilities to pre-emptively freeze money in accounts to ensure everyone takes a haircut at the moment of their choosing:

http://www.fdic.gov/news/news/financial/2008/fil08065.html#body

The next progression of the "no shorting" list will be the "no withdrawals" list.

I would say, that if you have not voted with your over-limit feet by August 18th, you should not surprised to be unable to do so any time thereafter. It's July 24th now, won't be long til large transaction holds take the TRx date across the 18th. Be kinda funny if the unintended consequence of these new powers was the starter pistol on a bunch of bank runs, as they will so clearly be used to scalp the over-100k crowd.

IMO, clear indication too may banks are going to fail for them to adequately insure them all. It seems evident to me they want to have people lose their money in one place and not have to insure it spread over multiple institutions.

[martscan]

Observations:

With respectful reference to the comments of Jake. Correct me if I'm wrong, but isn't the intent of stock traders simply to make money? Long, short, sidewise, strangle options, butterfly spreads, fandangeroowhoopee straddles or hand stands, where has it been written that 'benefiting the economy' is part of trading? Further, public opinion, Jake's too, notwithstanding, stock markets, per se, are NOT the real economy. And, short sellers can arguably be considered positives to a free market, if for no other reason than they afford liquidity to buyers and that, in turn, on the basis of Jake's thinking, can arguably be considered a role having a benefit to the economy. As to 'grinding' down a company...no financially healthy, profitable company can be ground down to a pulp, and legitimate short sellers of such a company will most likely be victims of a bear trap. As to Jake's inference that 'value creation' is a product of the converse of short sellers, i.e., buyers, longs, they do NOT create value in a stock...the company that issues the stock creates the value of the stock by making money, profits...the same objective of any participant in a capitalistic system...and that includes short sellers.

[martscan]

Is there anyone, not living under a rock, that has an interest in Downey, not aware of their deteriorating financial condition? Forgetting short sales and stock prices for the moment, isn't it as plain as the nose on your face that increasing scheduled items coupled with decreasing deposits is a recipe for a banking disaster? What is difficult to understand about a banking maxim that is as fundamental as "see Spot run"? According to the current, fashionable, cocktail party 'in' topic of characterizing short sellers and speculators as sociopaths dressed in black capes with long, thin moustaches who leer and hiss through their teeth, we should round them up, deny them due process and shoot them. I suspect that Downey has a large portfolio of C&D, construction and development, loans at high LTVs, which lack a secondary market and have to be eaten, along with a comparably thin unsaleable residential bundle...a deadly combination that will, logically, be fatal. As my 5th grade educated immigrant father would hammer into my head, "when your liabilities catch up with you, your assits in jail."