Downey Survives Game Even as Rules Change : Banking: The Newport Beach-based savings and loan weathered the crisis that felled other institutions, then had to adapt to a changing regulatory climate.
Downey Savings & Loan was a well-run, unconventional thrift that earned a good chunk of money by developing and leasing neighborhood shopping centers for more than 30 years.
In the tumultuous 1980s, though, numerous thrift executives with less expertise--and, often, less scruples--bankrupted hundreds of savings and loans, prompting Congress to enact investment laws so strict that the industry’s eventual demise seemed certain.
Downey’s game plan was ruined, but the Newport Beach-based financial institution has since transformed itself, going to great lengths to prove that it was not ready for the graveyard.
“And it did it profitably,” maintaining its strong financial health and continuing to pay quarterly dividends, noted industry analyst Campbell K. Chaney of Rodman & Renshaw brokerage in San Francisco.
Like many survivors of the industry debacle, Downey was a bystander in the carnage wreaked by high-flying, free-spending S&Ls.; It was a conservatively run organization that had to sell most of its solid money-making real estate operations because of congressional mandates passed in 1989 after so many recklessly operated thrifts failed.
Over five years, Downey sold 85% of its shopping centers and apartment complexes during Southern California’s worst recession since the 1930s, reducing its holdings from $370 million to $55.7 million at the end of December.
While it made the transition, the cost has been steep. Downey today is a far more conventional financial institution whose long-term future is now as uncertain as the industry in which it operates.
Downey’s changeover reflects both how healthy thrifts have adapted to the new regulatory environment and how they are benefiting from the slow but steady recovery of the Southern California economy.
For four years, Downey seemed to do little as it tested several heirs-apparent to its aging co-founders and sold most of its real estate holdings. Downey seemed ready for the auction block, not for the competitive mortgage market.
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Last year, however, the thrift found its new leader in veteran thrift executive Stephen W. Prough. It then used much of its extra cash to raise deposits and fund $1.9 billion in mortgage loans, nearly twice the amount loaned in the previous year, and to spur its growth 34%. By the end of December, it was the state’s 12th largest S&L; with $4.7 billion in loans, securities and other assets.
Now, the thrift and its newly formed holding company, Downey Financial Corp., will grow at a much slower pace as it rolls out new programs to sell annuities and to provide car loans through dealers and other auto brokers.
“The potential for Downey is absolutely excellent,” says co-founder Maurice L. McAlister, its 69-year-old chairman. “We have no fear at all of competing with the larger institutions. We can make decisions faster and we can compete on both the loan and the deposit sides.”
Downey’s resiliency aside, analysts believe that savings and loans will one day simply be absorbed into the commercial banking industry--one result of the 1980s bailout that is expected to cost U.S. taxpayers more than $500 billion over 30 years.
The reason, says analyst Chaney, is that the key indicators of profitability among S&Ls; are down from 20 years ago and aren’t likely to rise very much again, according to a study that his brokerage is wrapping up. The study argues that S&Ls; should sell out.
“Everybody following the thrift industry agrees that the industry is in decline,” he said. “That’s not to say that all will fail or go out of business; that won’t happen. But they won’t attract shareholder capital, and that will inhibit growth.”
The industry is falling apart, he said, mainly because federal regulations have all but strangled operations. The latest affront is the Federal Deposit Insurance Corp.’s decision to reduce premiums that commercial banks pay for insuring deposits to 4 cents for every $100 in accounts while continuing to require that S&Ls; pay 23 cents for every $100.
“With $3 billion in deposits, a thrift would pay $6.9 million a year in deposit insurance premiums, while a bank would pay only $1.2 million,” Chaney said. “It all leads us to the consolidation argument. Though thrifts can survive, they’re not going to make enough money to attract shareholders.”
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Regulations now require banks and thrifts to demand such detailed documentation from borrowers that business owners and home buyers are going elsewhere for loans, analysts said. Unregulated companies like General Motors Acceptance Corp., for instance, which was created to finance car loans, now offer mortgages and other consumer loans with much fewer documents demanded from borrowers.
“When the smoke clears in a couple of decades, the only things left standing will be large super-regional banks and small community banks, which will exist because they have the loyalty of their local communities,” said a former top executive at Downey.
“Institutions like Downey are not going to exist,” he said. “They’re too big to enjoy the loyalties of a community customer base and not big enough to compete with the giants.”
But with its restructuring, Chaney said, the S&L; can “easily survive” and post profits for a long time. “I think Downey will outperform the market in 1995,” he said, “but in the long haul--10 years or so--I think you’d be better off buying an S&P; index fund.”
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Just the same, he and other analysts are glad Downey finally got moving again and installed Prough last June as president and chief executive to run the operation.
In the last three months of the year, the S&L; funded $750 million in loans--a quarterly record. Nearly all were adjustable rate mortgages for single-family homes and started with teaser rates as low as 3.25% for the first three months. ARMs became popular with borrowers again--and bolstered California thrifts, in particular--as the Federal Reserve Board raised interest rates six times last year.
But ARMs with such low teaser rates are money-losing loans until they adjust to market rates. For Downey, most of the loans will adjust by April, and the rest by July. So the S&L;’s earnings should grow dramatically by mid-summer as long as rates stabilize or go down, analysts said.
The thrift earned $23.5 million last year, down 18% from $28.6 million the previous year, though its fourth-quarter profit rose 33% to $5.6 million from $4.2 million the previous year.
“Steve came in there, took a pretty staid company and jazzed it up by significantly enhancing its loan capability,” said Joseph Jolson, an analyst with Montgomery Securities in San Francisco.
Prough, 50, is the younger leader that the institution has been looking for since the late 1980s when regulators were pressing the thrift’s co-founders, McAlister and Gerald H. McQuarrie, to settle on a young successor. The S&L; had been through one leader and several heirs-apparent as the founders stepped into retirement, but no one seemed to work out. McQuarrie died two years ago.
Last spring, the thrift turned to Prough, a longtime friend of the two Macs. He had helped to build Western Financial Savings Bank in Irvine into a major S&L; and one of the nation’s largest providers of car loans.
Federal rules require that thrifts maintain 70% of their loans in home financing, so Western Financial pioneered a program under Prough in which it put $100 million or more in car loans into a pool that it sold to Wall Street, which issued securities based on the loans.
Prough plans to do the same thing at Downey. He recently hired Martin Brennan, who helped design Hyundai Motor America Inc.’s financing system nationwide, to set up a similar network in California to fund loans made by auto dealers. He also will oversee other consumer loans that the thrift will roll out later this year.
The car loan project, to begin next month, should grow to account for 5% to 10% of the thrift’s business, Prough said. More than $100 million worth of car loans should be ready for sale on Wall Street later this year, he said.
Shortly before Prough arrived, Downey rehired former top executive Jane Wolfe. Wolfe had been chief operating officer of the institution in the early 1990s while the board was sifting through candidates for president. She left for health reasons and later joined Liberty National Bank in Huntington Beach briefly before returning to run Downey’s loan department.
“Jane Wolfe, in my opinion, is probably the smartest person now on real estate loans,” McAlister said. “She’s a real pro.”
Wolfe, whom Prough credits for the S&L;’s surge in loans, decentralized loan operations by opening six real estate loan centers throughout the state to complement the S&L;’s 52 branches. The idea is to bring loan officers and processors closer to the customers, instead of forcing branches to process loans through headquarters.
Downey also hired William Bridges last June from American Savings & Loan to operate its branch system and to look for competitors’ branches the thrift could buy. He had been successful at buying deposits of failed institutions for American and merging the accounts into existing American branches.
As part of the thrift’s reorganization that formed its holding company this year, a sister company was formed to sell annuities. DFC Insurance Services will begin selling the securities early next month either at separate locations within branches or in offices nearby.
“The annuity business brings in fee income and offers customers another product,” said Joseph K. Morford III, an analyst with Alex. Brown & Sons brokerage in Baltimore. “There are not too many thrifts that sell annuities.”
Industry analysts always have thought highly of Downey. They used to point to the hidden value in its long-held portfolio of neighborhood shopping centers and apartment complexes.
But with most of those holdings gone they never saw the hidden value surface. The sales gave Downey gains of $55 million, but it put $40 million in reserve for possible losses in the future, leaving little for shareholders.
The thrift is likely to continue selling its real estate as it decides whether it will continue with a limited operation.
Analysts still like Downey, but two years ago, they saw no clear successor to McAlister and McQuarrie and figured the thrift would surely merge. Speculation rose when the S&L; hired Lehman Brothers investment bankers to find ways to “enhance shareholders’ value,” and the stock price reached a high of $27.75 a share in 1993.
Investors were disappointed when Downey announced late that year that it would remain independent and search for a new president, which it found in Prough. Wall Street sent the S&L;’s stock into a tailspin, pushing the price down as far as $14 a share last year before it began to rebound. It closed Friday at $15.25 a share on the New York Stock Exchange.
“For the moment, they’re not looking to sell, and Steve is going to get his chance to have a go at it,” said analyst Chaney. “But most investors wanted them to sell out.”
McAlister, whose family controls more than 23% of the stock, acts almost surprised that anyone would ever think he’d want to sell.
“The place was never for sale,” he says bluntly. “We were looking at all of our options and whether we should consider a sale, but we never got into talks with anyone. But that’s the way Wall Street goes. They make 100% in a month on an investment and they’re still not happy.”
Analysts can’t do much but watch his strategy play out.
“Downey’s destiny is in Maurice McAlister’s hands,” Chaney said. “When and if he decides to sell, it will be sold. It won’t take much effort to get it sold. It’s a good company with a lot to offer a good acquirer.”
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Downey on a Roll
Loan originations at Downey Savings & Loan have nearly quadrupled over five years. Last year, asset values also reached a five-year high. On the down side, revenue and profit continued to slide. An overview of the 37-year-old institution’s performance since 1990 (dollar amounts in millions):
Loan Originations* 1994: $1,810.1 * Excludes loan purchases
Total Assets 1994: $4,650.7
Revenue 1994: $124.1
Net Income 1994: $23.5
STOCK TREND
During the last five years, Downey’s closing stock prices have ranged from $10.13 in 1990 to $27.75 in 1993 when Wall Street wrongly speculated it might be sold. Monthly closing stock prices since 1990: Friday’s close $15.25
Source: Downey Savings & Loan, Dow Jones; Researched by JANICE L. JONES/Los Angeles Times
