Housing Bubble: Up In ARMs
We don't believe it. And even if we did, we'd be afraid to buy the stock. That's because most of the "earnings" that the bank reports are not the type that someone could spend in a grocery store. In other words, the earnings reside only on paper, NOT in Downey's corporate bank account. The reason for this curious condition is that Downey Savings has issued a very large number of "Pay-option ARMs," also known as negative-amortization (neg-am) loans. These devilish little mortgages contributed more than half the bank's earnings last quarter…sort of.
"Pay-option ARMs, which Californias took to like surfboards, allow the buyer to choose a form of monthly mortgage payment," James Grant explains. "And if the choice is 'none of the above,' the unpaid interest can be added to the loan balance (up to a point that is)."
In other words, these loans allow the homeowner to skip monthly payments, thereby INCREASING the unpaid balance. And when a mortgage balance increases instead of decreases, the loan-amortization is running in reverse. Hence the name, "negative-amortization" (Neg-am) loans.
Here's how neg-am mortgages work on Wall Street: Whenever a homeowner chooses to skip a payment, banks like Downey Savings still behave as though they received actual money. They treat the neg-am as if it were revenue. A little bit of this chicanery is harmless; a lot of it is worrisome.
It's bad on two fronts. First of all, when a borrower skips a payment, he skips a payment. Call it what you will, no check arrives in the mail. Even if Downey considers a skipped payment to be revenue (which it does), no revenue actually arrives at Downey HQ. Secondly, repeated skipped payments by multiple parties builds up a liability, without also building up any of the cash reserves required to offset the liability. That liability ultimately belongs to Downey.
In the quarter just ended, negative amortization "revenues" accounted for a whopping 57% of Downey's total revenues, compared to only 20% last year. "Accumulated negative amortization stood at $229 million," Grant reports, "or 18% of June 30 net worth, up 218% from the same quarter in 2005."
None of this would be so bad if the housing market were still booming. But that's not the case. Southern California home sales have dropped to their lowest level in nine years. And yet, the shares of Downey Financial have barely slipped from their all-time highs.
So.....This company has plans to increase its stock rices from 4.25 a share to 7.35 this year under these guidlines!!!! reporting false revenues that will ultimatly crumble.....Where is the SEC on this stuff???
