Class Action Lawsuit Filed Against Downey Financial

"On May 16, 2008, a class action lawsuit was filed in the United States District Court for the Central District of California against Downey Financial Corp."

Downey Financial Reports Higher Incidence of Delinquency When Minimum Payments Reset

Look at this amazing quote from the Downey Financial Corp. quarterly report (10-Q, March 31, 2008):

"A higher incidence of delinquency is expected when the minimum payments reset on our adjustable rate loans subject to negative amortization or interest only payments, whereby the interest rate is fixed for the first three to five years. For example, as of March 31, 2008, there were $976 million of loans subject to negative amortization or with interest only payments within our loans held for investment that have not been modified but had first time payment recasts since December 31, 2006, of which 36.1% were delinquent 30 or more days at March 31, 2008."

I first predicted this on April 4, 2007:

"More and more of the option ARM borrowers are going to be hitting the negative amortization 110% cap. ... When the option ARMs recast and the payments skyrocket, the delinquency rate is going to skyrocket."

Downey is down 80% since then.

Wednesday Interesting Articles

Real interest rates are now negative [Mankiw].

"Nothing in economic theory precludes negative real interest rates, or even suggests they should be anomalous. Nominal interest rates cannot be negative, because people would just hold cash instead of bonds,* but real interest rates can be negative. If real interest rates were very negative, investors could start investing in inventories of goods, but this arbitrage is not easy. Storing goods is costly, and many things in the CPI basket, such as services, are not storable at all.

In standard models of asset pricing, negative real interest rates are most likely to arise if growth expectations are particularly low or if uncertainty is particularly high."

Amit has a new post up about Downey [Kinnaras Capital Blog].

"...as we've covered, DSL's balance sheet greatly overstates its credit quality by ignoring market prices for the homes these mortgages are secured against. Based on Table II, there's about $2B in "extra" collateral value that DSL is implying its loans are secured against when market prices are much lower. NPAs are rapidly accelerating and the bank is facing a very challenging recast schedule. All of these obstacles are stacked against just $1.3B in capital which is why I've maintained my puts against DSL."

Collection of bearish data from [Mish's Global Economic Trend Analysis].

Downey Non-Performing Assets Leap Again

Downey Financial Corp. (NYSE: DSL) released monthly selected financial data for the thirteen months ended January 31, 2008.


"Restated NPAs" represents loans modified pursuant to Downey's borrower retention program.

Downey reports NPAs as a percentage of total assets. But not all of a bank's assets are loans. So, to make the NPA statistic more easily comparable across time, you can back out Downey's cash, investment securities, FHLB stock, and other assets that are not loans from the calculation.

The graph above shows NPAs and "adj-NPAs," which is NPAs as a percentage of only loans. (Both data series use Downey's new restated-NPAs numbers.)

They did not break out delinquencies in this report.

January Survey of Downey Financial (DSL) Defaults and Trustee's Sales

Today I updated my Downey Financial (DSL) survey of defaults and trustee's sales for January 2008. It's based on a sample of San Diego, San Joaquin, and Solano counties only. See the footnote for more on how this data is collected. (1).



I was waiting to see whether the jump in December was just an aberration related to the end of the year. Nope! Looks to me like a runaway train of defaulting borrowers.

This suggests that the Downey 8-K (which should come out in two weeks) will once again show massively higher non-performing assets.



(1) Not all counties make this data easily available online (especially in California). Los Angeles does not provide online access, and many of the counties that do have extremely cumbersome interfaces. My surveying method is to count all of the default notices and all of the notices of trustee's sale and trustee deeds during the time period. I do not make any adjustments for notices of rescission of default. I have found this data to be an excellent leading indicator, but no warranty is made as to its accuracy.

Disclosure: Own DSL Puts.

You Walk Away

What do you do if you are underwater on your house? You walk away.

1. We will stop your mortgage company from calling you.
2. You will immediately know the exact amount of days you have to live in your house payment free. ... We also will notify you if the lender is taking longer than expected subsequently giving you more time in your home payment free.
3. You will be enrolled in our affiliate credit repair plan. They have removed thousands of foreclosures from their clients credit reports.
4. You get a personal consultation with one of our highly experienced Real Estate Attorneys making sure the lender followed the law perfectly. If they did not, you may have a case against them.

It's about to become "acceptable" to stop paying your mortgage simply because you are underwater.

People are going to realize that they can sell their credit score in exchange for their mortgage balance. It will be the trade of a lifetime for millions of people.

Analysis of Downey Financial's (DSL) 2007 Earnings

Downey Announces Full-Year 2007 Results: "Downey Financial Corp. (DSL) reported a net loss for 2007 of $56.6 million or $2.03 per share on a diluted basis, compared to net income of $199.7 million or $7.16 per share in 2006."

I'm pressed for time, so I'll give you four very interesting charts, with a brief commentary on the fourth chart.



Downey reports NPAs as a percentage of total assets. But not all of a bank's assets are loans. So, to make the NPA statistic more easily comparable, you can back out Downey's cash, investment securities, FHLB stock, and other assets that are not loans from the calculation.


The graph above shows NPAs as a percentage of only loans.




Suppose that Downey was to go back to reserving 50% of their non-accrual loans. That would require adding an additional $114.9 million to the allowance for losses.

Doing that would have blown out their loss for 2007 from -$2.03 to -$6.16. (27.85M shares outstanding)

Downey Financial Restates Non-Performing Assets

From an 8-K filed today by Downey Financial.

"As required for all loans classified as troubled debt restructurings, loans modified as part of our borrower retention program must now be placed on non-accrual status but interest income will be recognized when paid. If borrowers perform pursuant to the modified loan terms for six months, the loans will be placed back on accrual status and, while still reported as troubled debt restructurings, they will no longer be classified as non-performing assets because the borrower has demonstrated an ability to perform..."

More detail at Calculated Risk.

For me, the most interesting thing is not the effect of this restatement, but simply the continued, sharp increase in plain-vanilla non-performing assets (NPAs) from November to December.

Of course, I had a pretty good indication of that last week, thanks to my tri-county survey.

Here's a restated chart showing NPAs before and after the change.


Here's the kicker: "As yet, we have not determined the impact this reporting change may have on previously reported financial statements, if any, but we expect to complete this analysis soon.”

December Survey of Downey Financial (DSL) Defaults and Trustee's Sales

Today I updated my Downey Financial (DSL) survey of defaults and trustee's sales for December 2007. It's based on a sample of San Diego, San Joaquin, and Solano counties only. See the footnote for more on how this data is collected. (1)

A "Default Notice" is the first step in the foreclosure process. It is a formal notice to a borrower that they are in default. Lenders typically send them after a couple months of missed payments.

Once the lender sends the default notice, the foreclosure clock starts ticking. In California, the borrower has 90 days from the Default Notice to become current on the mortgage. If not, the borrower receives a Sale Notice and shortly thereafter (unless the borrower pays up) the property is sold at auction/foreclosed.

Then the trustee's deed transfers title to whoever buys it at auction (usually the lender takes it back as Real Estate Owned). This is coded as a "TTEE Deed" in most of the California recorded document systems, and on the chart below.


So, on this chart, the blue portion indicates borrowers who are in arrears, and the red is borrowers whose foreclosure is imminent or has already happened.

Also, because Downey is an option-ARM lender, many of their borrowers are making artificially low, negatively-amortizing payments. This may be temporarily allowing people to avoid defaulting. I expect Downey's default numbers to worsen as borrowers hit loan interest resets and/or max out their negative amortization caps.

(1) Not all counties make this data easily available online (especially in California). Los Angeles does not provide online access, and many of the counties that do have extremely cumbersome interfaces. My surveying method is to count all of the default notices and all of the notices of trustee's sale and trustee deeds during the time period. I do not make any adjustments for notices of rescission of default. I have found this data to be an excellent leading indicator, but no warranty is made as to its accuracy.

Disclosure: Own DSL Puts.

CBS Year End Review: Downey Financial (DSL)

Downey Financial was down 52% for 2007 from the time that I initiated coverage on March 15, 2007. (Red S indicates blog posts where "sell" was reiterated.)

In my first Downey post I pointed out how Downey had put together a mortgage portfolio with multiple layers of risk including: limited verification of borrower income or assets; concentration in California; concentration in bubble years; use of mortgage brokers; negatively-amortizing Option-ARM loans.

On April 1, when people were still convinced that problems were limited to "subprime," I noted:

"M&T Bank - which is partially owned by Warren Buffett - is being forced to markdown and repurchase its Alt-A loans. Does anyone think that a bank owned by Buffett does worse underwriting than Downey? What does this imply about the value of Downey's portfolio of Alt-A loans?"

On April 12, I reported on an interesting conversation I had with an Arizona real estate agent:

I asked, "Did you ever have any garbage paper you couldn't push through Downey?" He just laughed.

It is amazing that we both set out, for different reasons and at different times, to find the loosest mortgage lender and independently found Downey.

This April 22 comparison of Downey and New Century illustrated that Downey's portfolio was, in some ways, riskier than a subprime lender's.

On June 12, I found out that hedge funds viewed Downey as a good buy. I pointed out that stated income loans made questionable economic sense for normal borrowers.

During the first week of every month, I release my Survey of Downey Financial Defaults and Trustee's Sales (see October and November). This has proven to be a great leading indicator of the Thirteen Month Selected Financial Data report that Downey releases mid-month.

I'll have the December survey posted in the next few days.

Here are the rest of my Downey-tagged posts. I still own Downey puts.

Sea Change in California REO Pricing

This is a bad sign for loss severity at our California Savings and Loans:

Banks and other mortgage lenders are starting to deeply discount their “owned” properties – the homes they have foreclosed on – says a report Thursday from ForeclosureRadar...

“A notable sea change occurred in November. Lenders are starting to aggressively discount properties” says ForeclosureRadar founder Sean O’Toole. “We were surprised by the magnitude of the discount and even more surprised that most of the homes went back to the bank with no investor bidding in spite of the price cut.”

In one example cited by ForeclosureRadar, 8215 Shay Circle in Stockton, purchased new in January 2006 for $481,000, saw a precipitous decline in price. The loan defaulted in 2007 and the lender discounted the opening bid at auction in November to $240,000. But even then the home went back to the bank with no investor bids, the report says.

Here is some Credit Bubble Stocks background on default rates and loss severity.

Investors are increasingly walking away from houses:

“More than one-fifth of 6,557 Bay Area properties that fell into foreclosure from January through September this year were owned by investors, according to a Chronicle analysis of public records compiled by DataQuick. Of properties repossessed by lenders, 1 in 6 had been owned by people who had two or more foreclosures in their names. Eighteen Bay Area investors had five or more foreclosures.”

Downey Financial (DSL) Non-performing Loans Jump Sharply

Last month, I predicted that Downey Financial (DSL) Non-performing assets (NPA) would be sharply higher in their next data release.

Today Downey released another Thirteen Month Selected Financial Data report, and the jump in NPAs surprised even me.


Downey reports NPAs as a percentage of total assets. But not all of a bank's assets are loans. So, to make the NPA statistic more easily comparable, you can back out Downey's cash, investment securities, FHLB stock, and other assets that are not loans from the calculation.



The graph above shows NPAs as a percentage of only loans. It reveals that calculating NPAs as a percentage of total assets has been steadily understating the increase.

I have consistently maintained a "Sell" on Downey since March 15 when it was selling for $64.87. It is down 52% since then. Take a look at this writeup from April 2007 on Downey's underwriting quality.

November Survey of Downey Financial (DSL) Defaults and Trustee's Sales

Today I updated my Downey Financial (DSL) survey of defaults and trustee's sales for November 2007. It's based on a sample of San Diego, San Joaquin, and Solano counties only. See the footnote for more on how this data is collected. (1)

A "Default Notice" is the first step in the foreclosure process. It is a formal notice to a borrower that they are in default. Lenders typically send them after a couple months of missed payments.

Once the lender sends the default notice, the foreclosure clock starts ticking. In California, the borrower has 90 days from the Default Notice to become current on the mortgage. If not, the borrower receives a Sale Notice and shortly thereafter (unless the borrower pays up) the property is sold at auction/foreclosed.

Then the trustee's deed transfers title to whoever buys it at auction (usually the lender takes it back as Real Estate Owned). This is coded as a "TTEE Deed" in most of the California recorded document systems, and on the chart below.

So, on this chart, the blue portion indicates borrowers who are in arrears, and the red is borrowers whose foreclosure is imminent or has already happened.

Also, because Downey is an option-ARM lender, many of their borrowers are making artificially low, negatively-amortizing payments. This may be temporarily allowing people to avoid defaulting. I expect Downey's default numbers to worsen as borrowers hit loan interest resets and/or max out their negative amortization caps.

Here's a projection for the 4th quarter based on October and November.


(1) Not all counties make this data easily available online (especially in California). Los Angeles does not provide online access, and many of the counties that do have extremely cumbersome interfaces. My surveying method is to count all of the default notices and all of the notices of trustee's sale and trustee deeds during the time period. I do not make any adjustments for notices of rescission of default. I have found this data to be an excellent leading indicator, but no warranty is made as to its accuracy.

Disclosure: Own DSL Puts.

Why I'm Not Covering

Another violent bear market rally. The market should have tanked instead after the awful news this week:

• Citadel bought a portfolio of E*Trade's residential loans. "Citigroup investment bank analyst Prashant Bhatia said E*Trade actually received 11 cents on the dollar for its portfolio, if you factor in that the brokerage received $800 million in cash minus 85 million shares it issued."
  
• E*Trade operated a bank, and these were relatively high quality loans. "...73 percent of the assets were backed by prime mortgages, or loans to people with solid credit." Downey and BankUnited have arguably lower quality loans, but the market is pricing them much higher than what E*Trade sold their loans for.
  
• Florida municipalities invest cash in a state-run investment pool. It seems that they were invested in low quality securities, and now Florida Halts Withdrawals From Local Investment Fund. There was a run on the fund, and some lucky cities got out in time. But not Jefferson County - their CFO says "I might not be able to pay our employees tomorrow."
• The Treasury's scheme to have lenders restructure loans has been on the news constantly. Russ Winter points out:
  
• "How exactly does the New Hope Alliance secure the agreement of ten or fifteen MBS holders to lower coupons and terms. ... Credit insurance is also put on against default and against altered conditions. If somehow some MBS were restructured under new terms this would in turn trigger a wave of claims against the credit insurance written against this securities. Would the insurers (if even still around) agree to pay these claims? This scheme as it applies to the mountain of MBS in the marketplace is just too much of a tangled web to ever be seriously implemented."

Ever calm and rational, Gary North wrote a good explanation of the rally:

On Tuesday, November 27, the Dow Jones Industrial Average rose by 215 points. The next day, it rose by 330 points.

Why? ... The news had broken that morning of the offer by the government of Abu Dhabi to pay $7.5 billion for 4.9% of America's largest and most prestigious bank, Citigroup.

The stock fund managers started buying as soon as the news hit. The official interpretation: "This decision by Abu Dhabi indicates that America's largest bank is in good shape. This is the end of the subprime crisis."

Here is my interpretation: A small percentage of a gigantic pool of oil-generated capital, which is managed by government bureaucrats in a city-state whose nation did not exist as recently as 1970, was used to buy 4.9% of the largest bank in the United States because this purchase was perceived as a better deal than buying T-bills denominated in a falling dollar.

Another reason for the rally is the eager anticipation of another cut in the Fed Funds rate. Bespoke did a post showing the reaction of various sectors to the last three Federal Reserve interventions in our markets:

Oops! Similar results in the homebuilding sector, of course. Rate cuts aren't going to keep the lights on if you're a real business that made bad investment decisions.

I put together a chart showing the performance of the Credit Bubble Stocks from this blog. Each data series begins on the date the stock was first mentioned on the blog.

(Click for larger version.)
S&P and cash are included for comparison.
You can see that Fed interventions and mistaken bullishness have caused sharp rallies, but they are fleeting and reality quickly catches up with the market.

Downey Financial NPAs Continue Exponential Trend; StanPac Bonds Down

Downey Financial NPAs
Today Downey released another Thirteen Month Selected Financial Data report. The rate of increase of their non-performing assets increases every time it is reported:


Downey reports NPAs as a percentage of total assets. But not all of a bank's assets are loans. So, to make the NPA statistic more easily comparable, you can back out Downey's cash, investment securities, FHLB stock, and other assets that are not loans from the calculation.

The graph above shows NPAs as a percentage of only loans. It reveals that calculating NPAs as a percentage of total assets has been steadily understating the increase.

I have consistently maintained a "Sell" on Downey since March 15 when it was selling for $64.87. It is down 51% since then.

Take a look at this writeup from April 2007 on Downey's underwriting quality.

I have a prediction: Downey NPAs will be sharply higher in their next data release. You can confirm that using the first chart in this post.

Standard Pacific Troubles
Today we had four people come to Credit Bubble Stocks searching for "Standard Pacific bankruptcy," which has to be some kind of record. Ouch!

The StanPac subordinated note is now yielding over 35%. Take a look at the price action:


I continue be short DSL and SPF.

October Survey of Downey Financial Defaults and Trustee's Sales

Today I updated my Downey Financial (DSL) survey of defaults and trustee's sales for September and October 2007. It's based on a sample of San Diego, San Joaquin, and Solano counties only. See the footnote for more on how this data is collected. (1)

Survey indicates that Downey borrowers continue to default and go to trustee's sales at a high rate.

A "Default Notice" is the first step in the foreclosure process. It is a formal notice to a borrower that they are in default. Lenders typically send them after a couple months of missed payments.

Once the lender sends the default notice, the foreclosure clock starts ticking. In California, the borrower has 90 days from the Default Notice to become current on the mortgage. If not, the borrower receives a Sale Notice and shortly thereafter (unless the borrower pays up) the property is sold at auction/foreclosed. Then the trustee's deed transfers title to whoever buys it at auction (usually the lender takes it back as Real Estate Owned). This is coded as a "TTEE Deed" in most of the California recorded document systems, and on the chart below.

So, on this chart, the blue portion indicates borrowers who are in arrears, and the red is borrowers whose foreclosure is imminent or has already happened.



Key point: all of these borrowers in default were almost certainly in default prior to the credit market crunch in August. That means that, beginning next month, we will see the effect of the drastically worse post-August credit, mortgage lending, and real estate markets.

The following chart extrapolates results for Q4 based on data collected in October.



At current rates, 4th Quarter 2007 will be the worst quarter. However, I expect the rate of default to increase and be worse than this linear projection. Now that housing inventory in CA has swelled and mortgage lending has tightened, it will be even more difficult for problem borrowers to refinance or sell their homes.

Also, because Downey is an option-ARM lender, many of their borrowers are making artificially low, negatively amortizing payments. This may be temporarily allowing people to avoid defaulting. I expect Downey's default numbers to worsen as borrowers hit loan interest resets and/or max out their negative amortization caps.

(1) Not all counties make this data easily available online (especially in California). Los Angeles does not provide online access, and many of the counties that do have extremely cumbersome interfaces. My surveying method is to count all of the default notices and all of the notices of trustee's sale and trustee deeds during the time period. I do not make any adjustments for notices of rescission of default. I have found this data to be an excellent leading indicator, but no warranty is made as to its accuracy.

Disclosure: Own DSL Puts.

Downey Financial Pessimism Beginning to be Vindicated

Downey Announces Third Quarter 2007 Results

Here is a graph of the dollar amount of delinquent loans, which are loans less than 90-days past due. (And, therefore, still considered performing.)

Look how sharply the 30-59 day delinquencies are up this quarter. Expect the 60-89 day delinquency series to snap upward in coming quarters, as they lag the 30-59 day series.

This increase in delinquencies has been driving the increase in non-performing assets (NPAs).

The exponential trend appears to be continuing unabated.

As I have explained previously, NPAs are calculated as a percentage of total assets. But not all of a bank's assets are loans. So, to make the NPA statistic more easily comparable, you can back out Downey's cash, investment securities, FHLB stock, and other assets that are not loans from the calculation.

This graph shows NPAs as a percentage of only loans. It reveals that calculating NPAs as a percentage of total assets has been steadily understating the increase.

In my previous post on Downey, I mentioned my surprise at an analyst who thinks this quarter's loss provision is "being made to avoid having to make other large provisions in future quarters." In other words, he thinks this is a one-time-only increase in the loss provision.

But take a look at Downey's loss allowance as a percentage of non-accrual loans:

Their loss allowance is substantially lagging the increases in non-accrual loans. This is in an environment where the Southwestern U.S. real estate markets get worse every month.

In other words, I think that Downey will be posting loss allowances at least this big in quarters to come.

Two other pieces of bad news:

• an increase of $3.5 million in net operations of real estate acquired in the settlement of loans due to a higher number of foreclosed properties, including 113 single family lots acquired through foreclosure of a land loan during the quarter
• The amount of negative amortization included in loan balances increased $11 million during the current quarter to $388 million or 4.70% of loans subject to negative amortization. During the current quarter, approximately 26% of loan interest income represented negative amortization, down from 29% in the second quarter of 2007 and 28% in the year-ago third quarter.

I continue to be short Downey Financial (DSL).

Downey Financial (DSL) Warning Shouldn't Come as a Surprise

This morning Downey warned that it will suffer a third quarter operating loss. The cause:

• An approximate $82 million provision for credit losses, which will increase the allowance for loan losses to approximately $144 million or 1.22% of loans held for investment.
• An approximate $9 million valuation reduction to real estate held for development to reflect declines in the value of single family home lots in which the company is a joint venture partner.

As a result, single family loan delinquencies, as well as losses from foreclosures, rose significantly during the third quarter and led to this quarter's large increase to the allowance for losses.

The loss evidently caught analysts by surprise.

The ramping up of loss provisions is not much of a surprise, but the size and acceleration of the increase was greater than expected, RiskMetrics Group analyst Zach Gast said.

The $82 million provision is likely being made to avoid having to make other large provisions in future quarters, Gast said. Gast is forecasting Downey Financial's loss provision in the fourth quarter will be closer to first quarter provision, which were less than $1 million.

Previously on Credit Bubble Stocks, I noted that Downey Financial's Non-Performing Assets were Increasing Exponentially. (That's part of my continuing coverage of Downey.)

I can't see how any analyst could look at this graph and be surprised by the size and increase in credit loss provisions. You can see it is following an exponential function very closely: the number of months it takes for non-performing assets to cross a threshold keeps decreasing.

I disagree with Mr. Gast's forecast that there will be a negligible increase in loss provisions in the 4th quarter for two reasons:

• First, they are probably under reserving for loan losses. On Aug 31, their NPA's were 1.96% or about $282 million but their provision is only going to be 1.22% or $144 million. That's in the face of increasing foreclosures and decreasing property values.
  
• Second, there is nothing to indicate that this or any other piece of bad Downey news is an outlier. The exponential trend is consistent with worsening anecdotal reports and broader market statistics.
  

At this time, I would also like to point out that Downey is down 18% since I recommended selling it in March. Also, here is its performance since I released my analysis of exponential NPA trends on September 19.



If you are trading Downey, I recommend that you subscribe to this blog, as we have a regular early-warning report on Downey's non-performing assets. It has proven to be a great leading indicator.

Mr. Gast actually put it pretty well himself in February:

“When there is good home price appreciation, you can get away with a lot of mistakes, but home price appreciation has stopped.

Downey Financial's Non-Performing Assets Increase Exponentially

On Friday, Downey Financial Corp. (DSL) released their latest THIRTEEN MONTH SELECTED FINANCIAL DATA.

Here are some charts showing data from the latest report and from the quarterly report. (You can click the charts to see larger versions.)

The first chart shows the percentage of loans that are non-performing (that is, more than 90 days past due). You can see that the growth is exponential.

If the growth of non-performing assets (NPAs) continues to follow this exponential function, we can extrapolate that they will reach 4% by the end of 2007, and 12% by next August.

One other interesting point about the NPAs is that they are calculated as a percentage of total assets. But not all of a bank's assets are loans. So, to make the NPA statistic more easily comparable, you can back out Downey's cash, investment securities, FHLB stock, and other assets that are not loans from the calculation.

This graph shows NPAs as a percentage of only loans. It reveals that calculating NPAs as a percentage of total assets has been steadily understating the increase.


Finally, here is a graph of the dollar amount of delinquent loans, which are loans less than 90-days past due. (And, therefore, still considered performing.)

Survey Indicates Downey Foreclosures are Skyrocketing

Today I updated my Downey Real Estate Owned (REO) survey for July and August 2007. It's based on a sample of San Diego, San Joaquin, and Solano counties only. See the footnote for more on how this data is collected.

Survey indicates that Downey borrower defaults and foreclosures are up sharply so far this quarter, and are increasing at an accelerating pace.

A "Default Notice" is the first step in the foreclosure process. It is a formal notice to a borrower that they are in default. Lenders typically send them after a couple months of missed payments. That means that this month's jump in Default Notices comes from borrowers who stopped making payments in the spring.

Once the lender sends the default notice, the foreclosure clock starts ticking. In California, the borrower has 90 days from the Default Notice to become current on the mortgage. If not, the borrower receives a Sale Notice and shortly thereafter (unless the borrower pays up) the property is sold at auction/foreclosed. Then the trustee's deed transfers title to whoever buys it at auction (usually the lender takes it back as Real Estate Owned). This is coded as a "TTEE Deed" in most of the California recorded document systems, and on the chart below.

So, on this chart, the blue portion indicates borrowers who are in arrears, and the red is borrowers whose foreclosure is imminent or has already happened.


So far this year, the survey of these counties has been highly correlated with Downey's reported results, making the survey a great leading indicator. So, I expect that for third quarter, Downey will report non-performing loan statistics that are a multiple of the numbers in these charts.

The following chart extrapolates results for Q3 based on data collected in July and August.



There were 73 properties listed on Downey's website on May 14, 2007. Today there are 113.

Because Downey is an option-ARM lender, many of their borrowers are making artificially low, negatively amortizing payments. This may be temporarily allowing people to avoid defaulting. I expect Downey's default numbers to worsen as borrowers hit loan interest resets and/or max out their negative amortization caps.

Footnotes:
(1) Not all counties make this data easily available online (especially in California). Los Angeles does not provide online access, and many of the counties that do have extremely cumbersome interfaces. My surveying method is to count all of the default notices and all of the notices of trustee's sale/trustee deeds during the time period. I do not make any adjustments for notices of rescission of default. I have found this data to be an excellent leading indicator, but no warranty is made as to its accuracy.
(2) I have covered my NCT short. There is relatively little public information about their portfolio and it's possible that the market has overreacted.