Downey Stock Beating the Big Guys
Conventional wisdom has it that smaller thrifts like Downey Savings & Loan have little chance of competing against the giant S&Ls;, banks and mortgage companies.
So why, then, is stock in parent Downey Financial Corp. outpacing that of all other large S&Ls;, including stalwarts Golden West Financial Corp. and Washington Mutual Inc.? Especially now, when financial institutions are attracting Wall Street money that has been fleeing the technology sector?
Maurice L. McAlister, the 75-year-old Arkansas native who co-founded Downey 43 years ago and still holds the reins as chairman, gives a Goldilocks answer: Downey’s size is just right.
With assets of $10.4 billion, the Newport Beach-based thrift is large enough to compete technologically with the big boys, he said. Yet it’s small enough to be nimble--to react quickly to interest rate changes.
“We can get things moving in a different direction in a hurry,” McAlister said.
Going online faster than rivals, Downey has automated loan applications and put services a few keystrokes away for computer users. Like Wells Fargo, it is one of the few banks or thrifts to open branches in supermarkets, urging tellers to chat up potential customers while helping to bag groceries.
And using capital from a Downey Financial securities sale, the S&L; beefed up its portfolio of adjustable-rate mortgages by 50% last year. As the rates ratcheted higher on all those loans, Downey wowed investors by reporting far higher earnings this year than analysts had foreseen.
The market responded by more than doubling its stock price over the last six months, hitting its all-time high of $51.38 a share during trading Wednesday and making McAlister’s 20% portion alone worth $279 million.
“There are a lot of happy campers around here these days,” he said.
In truth, there’s happiness throughout his industry.
As investors dump highflying tech stocks, financial stocks that carry low credit risks are gaining attention, notes Chad Yonker, a thrift analyst at Fox-Pitt, Kelton Inc. The home loans at the core of S&Ls; are far less risky than the business loans that dominate commercial banks’ portfolios, and thrifts are benefiting from the state’s long-running rise in home prices and strong housing sales.
On Nov. 30, as tech stocks dragged the Nasdaq market down 109 points, the stock price rose for 14 of the 19 thrifts that Yonker covers. And financial stocks continued to rise last week even as tech stocks rallied. Downey’s shares gained 13 cents Thursday to close at $49.38, up 145% this year on the New York Stock Exchange.
The recent success for McAlister and Downey follows decades of economic storms, waves of changing regulations and forecasts in the early 1990s that the then-disaster-plagued industry would disappear.
S&Ls; were the chief source of mortgages 20 years ago, but their ranks have thinned drastically. In 1966, the nation had 4,500 S&Ls; with $129 billion in assets--basically loans and other investments. By 1988, when industry assets peaked at $1.4 trillion, the number had fallen to 2,949, according to the Office of Thrift Supervision.
Though the industry is healthy, some economic trends are worrisome, says Scott Albertson, the federal agency’s managing director of supervision.
High consumer debt and an uptick in bankruptcies loom as threats, especially to S&Ls; involved in less traditional arenas such as auto, construction and small-business loans. And the gap between long- and short-term interest rates has closed, reducing the margin between what thrifts pay for deposits and what they earn from loans, he said.
But for now, at least, many S&Ls; are thriving, if only as takeover targets. Total assets at 1,082 remaining thrifts have risen from $763 billion three years ago to $908 billion today, the OTS reports.
With shares of Downey Financial at record levels and nothing left for McAlister to prove, some observers say the company soon will join the ranks of sold-off thrifts. “The stock reflects a big ‘for-sale’ premium,” one competitor said.
But others consider a sale unlikely any time soon.
“As long as McAlister is alive, Downey is going to remain independent, but if something happens to his health, Downey probably cannot remain independent,” said Paul J. Miller, a Friedman, Billings, Ramsey & Co. analyst. “I think there would be too much pressure” on other shareholders to sell.
McAlister, a loquacious and sometimes cantankerous man who lives in Bullhead City, Ariz., when he isn’t bass fishing in Mexico or hunting elk near the Grand Canyon, says he has no intention of selling. “I don’t need the money,” he said.
Once best known for developing shopping centers, Downey now focuses on home loans, which are more reassuring to investors. It sells the fixed-rate loans it originates to investors and stuffs its own portfolio with adjustable-rate mortgages, most of which are altered on a monthly basis.
Its ballooning portfolio of adjustable mortgages earned ever more as the Federal Reserve raised interest rates six times from June 1999 to last May. Now, with rates stable, Downey’s loan income continues to rise as low “teaser” rates adjust fully to market levels.
Should rates drop, the thrift is prepared to react quickly when customers begin refinancing their adjustable loans, McAlister said. Downey has computers programmed to generate letters pitching its own fixed-rate loans.
“Downey has become a baby Golden West,” Miller said. “No one really can compete with Golden West on costs--but what they’re doing is very similar.”
That is high praise indeed. Golden West, the Oakland parent of World Savings, is generally regarded as the most tightly run S&L; operation in the business.
Downey is now the 16th-largest U.S. thrift, though its $10.4 billion in assets is small compared with Golden West’s $52.4 billion or the whopping $191 billion at Seattle’s Washington Mutual.
When the S&L; opened in Downey in October 1957, McAlister and co-founder Gerald H. McQuarrie focused on building and leasing out shopping centers, putting a branch in each neighborhood mall and prospering at that tricky business through the 1980s, when a host of risky ventures brought down hundreds of other thrifts and nearly ruined the industry.
But when investment rules tightened with the 1989 federal bailout of the industry, Downey had to liquidate holdings worth $600 million at the same time the government sold its own vast portfolio of real estate inherited from failed thrifts--and as the California economy tanked.
The S&L;’s shopping centers were solid enough that the thrift easily survived. But its executives still smart from the process: “We left a lot of money on the table,” said Chief Executive Daniel D. Rosenthal, a 25-year veteran who came up through Downey’s real estate side.
Even so, profit has flowed from its first days. It has had only two money-losing years, in the early 1980s, when nearly all thrifts were swimming in red ink from double-digit inflation.
For the first nine months this year, Downey’s net income grew 73% to $76.3 million, or $2.70 a share, from $44 million, or $1.56 a share, for the same period last year. Total revenue rose 49% to $617.6 million for the period. It has 113 branches, mainly in Southern California.
During the last decade, Downey experimented with auto loans, annuity sales and other non-mortgage products in an effort to follow the industry to diversify. But it also burned through several chief executives brought in from outside in the process.
“We used our best judgment at the time. We turned out to be wrong,” McAlister said of the turmoil. “Today I’d rather make the single-family loan.”
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Wall Street Darling
Investors fell in love with Downey Savings & Loan this year, driving its shares to an all-time high of $51.38 Wednesday and making the Newport Beach thrift the biggest gainer among major publicly owned S&Ls.; A look at top percentage gainers among the biggest S&Ls;, and Downey’s year-to-date stock gains:
