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, fewer 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, notes industry analyst Campbell K. Chaney of Rodman & Renshaw brokerage in San Francisco.
Like many survivors of the industry debacle, Downey was a bystander to 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 property holdings from $370 million to $55.7 million at the end of December.
Although 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.
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 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."
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. Non-regulated companies such as General Motors Acceptance Corp., for instance, which was created to finance car loans, now offer mortgages and other consumer loans with many 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.
Prough, 50, is the leader that the institution had 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, they turned to Prough, a longtime friend of the two founders. 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. 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.
In the last three months of the year, the S&L; funded $750 million in loans--a quarterly record. Nearly all of it was for single-family homes.
Still, its earnings fell 18% to $23.5 million last year from $28.6 million in 1993. Its fourth-quarter profit, though, rose 33% to $5.6 million from $4.2 million in '93.
Analysts still like Downey, but two years ago they figured the thrift would surely merge. Investors were disappointed when Downey announced late in 1993 that it would remain independent.
Wall Street sent the S&L;'s stock into a tailspin, pushing the price down as low 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.
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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):
* Excludes loan purchases
** Includes assets, revenue and net operating losses from acquisition of Butterfield Savings & Loan in 1988.
*** Includes $15.1 million addition due to change in income-tax accounting standards.
Source: Downey Savings & Loan, Dow Jones. Researched by JANICE L. JONES / Los Angeles Times