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

This article was originally on a blog post platform and may be missing photos, graphics or links. See About archive blog posts.

‘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.