Despite long being talked about as an acquisition target, Downey Savings & Loan seems content to hold its own as not only the largest depository institution headquartered in Orange County, but the largest independent depository institution based in all of Southern California.
Downey has jumped on the Internet, expanded its subprime lending operations and reported record earnings for its second straight year. It also just shed its auto-finance division, last fall raised $120 million in an issue of capital securities, and has plans to grow its bread-and-butter residential lending operation with the new capital.
The lender just had two record years of earnings due mostly to its residential lending operations, and analysts say its earnings should continue to be strong this year, as well.
With all the gyrations on Wall Street, Downey looks downright placid as a stock. The company has been trading in the $18 to $25-per-share range for almost two years; it recently was around $23. “You don’t see it jump up and down, “said Paul Miller, a thrift analyst with Friedman Billings Ramsey.
Downey’s CEO, Daniel Rosenthal, has been at the post for almost two years, which is right around the breaking point for the position in recent Downey history. Downey’s iron-fisted, 73-year old chairman, Maurice McAlister, has gone through five CEOs in the last 10 years.
Maybe Rosenthal, a long-time employee of McAlister’s and his ex-son-in-law, will last longer in the post. But nobody doubts that it’s McAlister who ultimately calls the shots. And maybe it’s that sense of business-as-usual that explains why, for all of the speculation about a takeover, Downey’s stock doesn’t reflect any takeover premium.
The company’s stock was recently trading at just 1.1 times its book value, compared with 1.6 times for Seattle-based rival Washington Mutual and 1.7 times for Oakland-based Golden West Financial Corp., parent of rival World Savings & Loan. Downey’s price-to-earnings ratio, of close to 8, was about the same as WaMu’s, but still behind the 11.5 P/E of Golden West. On the other hand, Downey compares more favorably with San Francisco-based Golden State Bancorp, parent of rival California Federal Bank, which had a price-to-book ratio of 1.2 and a P/E of 6.
Though it has the most deposits of any financial institution based in the county, Downey ranks fourth among savings & loans in the OC marketplace, giving way to regional giants Washington Mutual, California Federal and World Savings.
Downey has about $1.5 billion in deposits in OC, while employing 1,126 here.
As for its standing among depository institutions based in Southern California, as of Dec. 31 Downey ranked first in assets, nosing out Los Angeles-based (but Japanese-owned) Sanwa Bank California, $9.4 billion to $9.2 billion. Sanwa held the edge in deposits, $6.9 billion to $6.6 billion for Downey.
Downey finished off 1999 with $63.8 million in earnings, up 10% from 1998, and up 20% if income in 1998 from a one-time settlement is excluded.
Downey’s stock also beat Merrill Lynch’s earnings-per-share estimate by 35% for the last quarter of 1999, hitting 70 cents. Merrill Lynch increased its 2000 EPS estimate for Downey to $2.30.
“Downey Savings & Loan’s basic franchise seems to be improving and the company provides one of the few meaningful entry points into the southern part of the Golden State,” said a recent Merrill Lynch report.
Boost from Online Services
Downey also has gotten a boost from its venture into online mortgages.
“They have a nice little Internet play and that is a big growth area,” Miller said.
Downey’s online mortgage site has brought in about 5% of its originations, according to Christopher Buonafede, a research associate with Fox-Pitt Kelton. And that business should grow since Downey just struck a deal with AOL to provide access to Downey Savings’ automated home-loan application process from several AOL brands. Under the agreement, Downey will have a link to AOL’s Personal Finance Channel and banner ads on web pages of AOL, Netscape Netcenter and CompuServe.
Downey also grew its bricks-and-mortar branch network last year by 13, to 104 branches total, and plans to expand by about the same number in 2000. The sale of its auto-finance division will provide the capital for its expansion plans and to maintain its growth. Downey’s CFO, Thomas Prince, said the company is looking to redeploy the capital from the sale into its primary moneymaker, its residential lending operations.
Downey’s loans and mortgage-backed securities totaled $8.7 billion, or 93% of the company’s assets at the end of 1999, an increase of $3 billion from 1998. The $3 billion increase also reflects a consumer shift to adjustable-rate mortgages from fixed-rate loans, primarily caused by recent interest-rate increases. Banks typically do not hold on to fixed-rate loans, and sell them off in the secondary market, thus taking assets off of the balance sheet.
Interest Income Up
Downey’s total interest income has been on a steady rise for most of the decade, finishing off the ’90s with a 21.2% increase in 1999 to $533.8 million. (In 1995, the figure was $318.8 million.)
But, said Prince, “Our growth will not continue at that pace without additional capital.”
Which is one of the reasons that Downey is an attractive buyout target.
The company declined to comment on any acquisition or merger possibilities. But others note that a larger institution could provide the capital for an expansion of Downey’s operations and the S & L; would be a good base for entry into the California market.
“They have been an obvious potential target for many years,” said Norman Katz, the managing partner at MCS Associates in Irvine.
In the mid-’90s it was rumored that both American Savings and Home Savings were looking to buy Downey. But Seattle-based Washington Mutual eliminated those threats when it purchased the potential suitors, in 1996 and 1998, respectively.
Drawbacks to Buyout
“There are plenty of banks that would love a presence in that market,” Miller said. “You have a lot of thrifts in California, but not with that size.”
But, said Miller, “the California presence comes at a big premium.”
If Downey is going to change hands, its would be sold at a high cost to the buyer.
There may not be many thrifts that would want to acquire Downey, since the majority of its business comes from the low-yielding residential portfolio.
“They (the buyer) would have to restructure things around,” Miller said.
Meanwhile, “banks are not particularly enamored with acquiring savings and loans, although Downey has done a fairly strong job of trying to establish bank-like components,” Katz said in regard to Downey’s commercial lending efforts.
To generate enough earnings to compensate for the acquisition, a buyer would have focus on high-yielding products, such as commercial lending or the subprime arena. Downey’s subprime operations grew 216% in 1999 to $1.2 billion.
But ultimately, Downey’s direction depends on the decisions of one man: chairman McAlister, who through himself and family members controls about 40% of the company’s stock.
“There’s one guy in charge there,” said Rick Shuttleworth, a senior vice president at Silicon Valley Bank. “If he feels like selling it, it will be sold.” n
