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 Downey Announces Second Quarter 2008 Results
   Thursday, July 24, 2008 6:00:00 AM ET

Downey Financial Corp. (DSL ) reported a net loss for second quarter 2008 of $218.9 million or $7.86 per share on a diluted basis, compared with net income of $32.7 million or $1.17 on a diluted basis per share in the year-ago second quarter.

The $309.5 million unfavorable change in pre-tax income/(loss) between second quarters was due primarily to:

    -- A $249.4 million increase in the provision for credit losses;
    -- A $28.5 million or 25.6% decline in net interest income due to a lower
       level of interest-earning assets and a lower effective interest rate
       spread;
    -- A $26.2 million increase in operating expense primarily due to higher
       costs related to the operation of real estate acquired in settlement of
       loans; and
    -- A $5.2 million unfavorable change in income from real estate and joint
       ventures held for investment, as an increase in gains from sales was
       more than offset by provisions for loss to reflect declines in the
       value of single family home lots in which the company is a joint
       venture partner.


For the first six months of 2008, the net loss totaled $466.6 million or $16.75 per share on a diluted basis, compared to net income of $75.6 million or $2.71 per share on a diluted basis for the first six months of 2007.

Downey separately announced today that its Board of Directors has appointed Thomas E. Prince, currently Downey’s Executive Vice President and Chief Operating Officer, as the Company’s interim Chief Executive Officer, replacing Daniel D. Rosenthal, who has retired. The Company also announced that Maurice L. "Mac" McAlister, Chairman of the Board and the Company’s founder and largest shareholder, has retired from the Board of Directors. Two independent directors, Michael D. Bozarth and Gary W. Brummett will become Chairman and Vice Chairman of the Board, respectively, succeeding Messrs. McAlister and Rosenthal in those capacities.

NET INTEREST INCOME

Net interest income totaled $82.9 million in the second quarter of 2008, down $28.5 million or 25.6% from a year ago, reflecting a $2.367 billion or 16.3% decline in average interest-earning assets to $12.168 billion and a decline in the effective interest rate spread. The average effective interest rate spread was 2.73% in the current quarter, down 0.34% from a year ago but up 0.10% from the first quarter of 2008. The decline in the current quarter effective interest spread from a year ago primarily reflected the negative impact of a higher proportion of non-performing assets. Although non- performing assets increased in the current quarter from the first quarter of 2008, the earning asset yield did not decline as rapidly as the cost of funds, resulting in an increase in the effective interest rate spread.

For the first six months of 2008, net interest income totaled $166.7 million, down $69.9 million or 29.6% from the year-ago period.

PROVISION FOR CREDIT LOSSES

During the current quarter, the provision for credit losses totaled $258.9 million, up $249.4 million from a year ago.

At June 30, 2008, the allowance for credit losses was $733.7 million, comprised of $732.3 million for loan losses and $1.4 million for unfunded loan commitments which is reported within accounts payable and accrued liabilities. The allowance for credit losses increased $186.0 million this quarter, of which $29.8 million was related to specific allowances associated with certain troubled debt restructurings pursuant to our borrower retention program which is discussed more fully below in the section entitled "Non-Performing Assets." These specific allowances will be accreted into interest income over the remaining life of the modified loans as long as they remain on accrual status. The balance of the increase in the allowance for credit losses primarily reflects further declines in the value of underlying home collateral as well as further increases in delinquent loans.

Downey’s allowance methodology incorporates assumptions related to default probabilities, loss severities and loss horizons based on historical experience, current market conditions, and the unique characteristics of each borrower, loan and underlying collateral. On a comparative basis, these factors individually increase or decrease the amount of the allowance for loan losses from prior periods. Both default probabilities and loss severities increased in the current quarter as a result of the challenging market conditions continuing to affect the residential housing market. In particular, collateral values have been trending downward in the greater Sacramento, Stockton, Modesto and Contra Costa areas of Northern California, the Inland Empire and San Diego County. Also, the horizon over which borrower defaults are projected to occur has shortened. The shorter default horizon reflects our recent experience of losses emerging earlier in the current environment compared with prior periods as the loan portfolio has continued to age, real estate values have continued to decline and borrowers have continued to experience reduced levels of equity in their homes.

Net loan charge-offs totaled $70.2 million in the current quarter, compared with $1.0 million a year ago. Net charge-offs in the current quarter are primarily related to residential one-to-four unit loans, with the annualized net charge-off ratio associated with these loans increasing to 2.60% from 0.03% a year ago.

For the first six months of 2008, the provision for credit losses totaled $495.7 million and net charge-offs were $107.3 million. This compares with a $10.1 million provision for credit losses and net charge-offs of $1.7 million a year ago.

OTHER INCOME

Other income totaled $12.1 million in the current quarter, down $5.5 million or 31.2% from a year ago. Primary contributors to the decline between second quarters were:

    -- A $5.2 million unfavorable change in income from real estate and joint
       ventures held for investments. Net gains from sales totaled
       $6.2 million in the current quarter, up $5.8 million from a year ago.
       More than offsetting the increase in gains from sales was an
       $11.1 million increase in provision for losses between second quarters,
       as the current quarter included provisions for loss to reflect declines
       in the value of single family home lots in which the company is a joint
       venture partner.
    -- A $4.4 million decline in net gains on sale of loans and mortgage-
       backed securities, reflecting both a decline in loans sold and a lower
       gain per dollar of loan sold. Net gains in the current quarter totaled
       $4.6 million, including a $2.1 million gain due to the impact of
       valuing derivatives associated with the sale of loans. Excluding the
       impact of the SFAS 133 derivative valuation, a gain was realized equal
       to 1.05% on secondary market sales of $235 million, compared with the
       year-ago gain of 1.42% on secondary market sales of $570 million.


These unfavorable items were partially offset by a $4.8 million increase in income from loan servicing fees due primarily to a favorable change in the fair value of mortgage servicing rights.

For the first six months of 2008, other income totaled $21.0 million, down $14.2 million or 40.4% from a year ago.

OPERATING EXPENSE

Operating expense totaled $88.5 million in the current quarter, up $26.2 million or 42.0% from a year ago. The increase primarily reflected an increase of $23.2 million in net operations of real estate acquired in the settlement of loans due to a higher number of foreclosed properties. General and administrative expense increased $3.0 million or 4.8% between second quarters, due primarily to an increase in the other general and administrative expense category, which was up $2.8 million. That increase was primarily attributable to an adjustment in the prior year period related to reserves associated with workers’ compensation insurance claims. Also contributing to the increase between second quarters was a $1.2 million increase in regulatory assessments due primarily to a special credit received in the prior period. Partially offsetting these unfavorable items was a $1.1 million decline in advertising expense. Although salaries and related costs were essentially unchanged between second quarters, the current quarter included severance costs of approximately $1.0 million associated with the previously announced departure of Downey’s former President.

For the first six months of 2008, operating expense totaled $177.5 million, up $49.5 million or 38.7% from a year ago.

INCOME TAXES

A tax benefit of $33.5 million was recorded in the current quarter, reflecting an effective tax rate of 13.3%, compared with the year-ago effective tax rate of 42.7%. For the first six months of 2008, the effective tax rate was 3.9%, compared with 43.4% a year ago.

The lower effective tax rates for the current year resulted from the establishment of a valuation allowance against the deferred tax asset. The deferred tax asset resulted from a significant increase in the loan loss allowance due, in part, to the factors discussed above in "Provision for Credit Losses." To the extent the loan loss allowance is not allocable to specific loans, it represents future tax benefits which would be realized when actual charge-offs are made against the allowance. To the extent available sources of taxable income, including prior years’ tax returns, are deemed per generally accepted accounting principles to be insufficient to absorb tax losses, a valuation allowance is necessary. The valuation allowance was increased by $72 million in the current quarter to $183 million against tax assets of $240 million.

Since generally accepted accounting principles require Downey to spread its expected annual tax benefit across the entire year through an effective tax rate, we expect to continue realizing a tax benefit in future months, but, as explained above, at much smaller levels than in the prior year.

ASSETS, LOAN ORIGINATIONS AND DEPOSITS

At June 30, 2008, assets totaled $12.632 billion, down $2.271 billion or 15.2% from a year ago. During the current quarter, assets declined $499 million due primarily to a decline of $605 million in investment securities. That decline was partially offset by a $72 million increase in real estate acquired in settlement of loans, net, and a $64 million increase in income tax receivable. Although gross loans held for investment increased by $231 million, this growth was substantially offset by a $186 million increase in the allowance for loan losses. Included within loans held for investment at quarter end were $6.242 billion of single family adjustable rate mortgages subject to negative amortization, down $721 million from March 31, 2008. These loans comprised 57% of the single family residential loan portfolio held for investment at quarter end, compared with 76% a year ago. The amount of negative amortization included in loan balances declined $31 million during the current quarter to $344 million or 5.5% of loans subject to negative amortization. During the current quarter, approximately 15% of loan interest income represented negative amortization, down from 20% in the first quarter 2008 and 29% in the year-ago second quarter.

Loan originations (including purchases) totaled $1.027 billion in the current quarter, down $182 million or 15.0% from $1.209 billion a year ago, but up from $676 million in the first quarter of 2008. Loans originated for sale declined $283 million or 57.2% to $212 million, while single family residential loans originated for portfolio increased $52 million or 7.4% to $751 million from a year ago. In addition to single family residential loans, $65 million of other loans were originated in the current quarter, up from $15 million a year ago.

Not included in the above originations are loans for which we modify the terms of a borrower’s loan. During the current quarter, we modified $320 million of loans associated with our portfolio retention program, wherein the borrower was current with their loan payments and the new interest rate was no less than that afforded new borrowers, and $79 million of loans at below market interest rates in loan workout situations. Most of the modifications were adjustable rate loans, which permitted negative amortization, that were modified into five-year interest-only adjustable rate loans with interest rates that adjust semi-annually but do not permit negative amortization.

Deposits totaled $9.881 billion at quarter end, down $1.366 billion or 12.1% from a year ago. Although deposits declined from a year ago, the number of checking accounts were up modestly over a year ago. At quarter end, the number of branches totaled 174 (169 in California and five in Arizona). At quarter end, the average deposit size of our 84 traditional branches was $94 million, while the average deposit size of our 90 in-store branches was $22 million. During the current quarter, borrowings increased by $85 million and represented 14% of total assets at quarter end.

NON-PERFORMING ASSETS

Non-performing assets increased during the quarter by $395 million to $1.958 billion and represented 15.50% of total assets, compared with 7.77% at year-end 2007 and 1.53% a year ago.

A borrower retention program was initiated at the beginning of the third quarter of 2007 to provide borrowers who are current with their loan payments a cost effective means to change from an adjustable rate loan that permits negative amortization to a less costly financing alternative. Those loans are considered troubled debt restructurings and have been placed on non-accrual status even though the interest rate following modification was no less than that afforded new borrowers. The reason for this is because the modified interest rate was lower than the interest rate on the original loan and the loan was not re-underwritten to prove that the new interest rate was, in fact, a market interest rate for a borrower with similar credit quality. Interest income is recorded as these borrowers make their loan payments and in the current quarter $11.3 million was recognized, including $1.5 million of amortization of the associated impairment allowance. If these borrowers perform pursuant to the modified terms for six consecutive 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 will have demonstrated an ability to perform in accordance with the loan modification and the interest rate was no less than those afforded new borrowers at the time of modification.

To the extent borrowers whose loans were modified pursuant to the borrower retention program are current with their loan payments and included in non- performing assets, it is relevant to distinguish those from total non- performing assets because, unlike other loans classified as non-performing assets, these loans are paying interest at interest rates no less than those afforded new borrowers. At June 30, 2008, $548 million or 82% of such borrowers had made all loan payments due. Accordingly, the 15.50% ratio of non-performing assets to total assets includes 4.34% related to performing troubled debt restructurings, resulting in an adjusted ratio of 11.16%.

Through June 30, 2008, $347 million of loans modified pursuant to our borrower retention program have been removed from non-performing status because they met the six-month payment performance threshold. Of all loans modified pursuant to the borrower retention program, including both those classified as non-performing as well as those removed from non-performing status, 87% have made all payments due.

At June 30, 2008, real estate acquired in settlement of loans totaled $262 million. Included are 888 single family homes, one property consisting of 113 single family lots and one property consisting of raw land for approximately 545 single family lots. During the quarter, 522 new single family homes were acquired, while 209 were sold. As of quarter end, 87 single family homes were in escrow to be sold and offers were being negotiated on an additional 84 homes.

REGULATORY CAPITAL RATIOS

At June 30, 2008, Downey Financial Corp.’s primary subsidiary, Downey Savings and Loan Association, F.A., had core and tangible capital ratios of 7.57%, and a total risk-based capital ratio of 14.31%. As previously reported, the Bank’s regulatory capital position was enhanced by $62 million during the current quarter from a contribution of $50 million of equity from the holding company and a $12 million dividend paid by DSL Service Company, the Bank’s wholly-owned real estate subsidiary. This was more than offset by the net loss recorded in the current quarter.

Certain statements in this release may constitute "forward-looking statements" under the Private Securities Litigation Reform Act of 1995, which involve risks and uncertainties. Forward-looking statements do not relate strictly to historical information or current facts. Some forward-looking statements may be identified by use of terms such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates," or words of similar meaning, or future or conditional verbs such as "will," "would," "should," "could" or "may." Downey’s actual results may differ significantly from the results discussed in such forward-looking statements. Factors that might cause such a difference include, but are not limited to, economic conditions, competition in the geographic and business areas in which Downey conducts its operations, new, changed or increased regulatory restrictions, pending or threatened litigation, a decrease in Downey’s customers, including a decrease in Downey’s deposit base, the possible loss of key personnel, the inability to successfully implement strategic initiatives, changes in deposit flows and loan demand, risks associated with industry concentration with respect to deposits, risk of credit losses, risk associated with residential mortgage lending, risk associated with a slowdown in the housing market or high interest rates, fluctuations in interest rates, credit quality, the outcome of ongoing audits by taxing authorities and government regulation. Downey does not update forward-looking statements to reflect the impact of circumstances or events that arise after the date the forward-looking statements were made, except as required by law. Downey is not able to make any assurances, including but not limited to any assurances that the increased rate of sale of foreclosed homes will continue in future periods, the percentage of unsold homes in escrow or under negotiation will be representative of the number or percentage of homes sold in future periods, the improved quality of our loan portfolio will continue in future periods, we will have adequate liquidity in future periods, or capital levels will exceed "well-capitalized" levels in future periods.

                     DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                 (Dollars in Thousands, Except Per Share Data)

                                     Jun. 30,     Dec. 31,     Jun. 30,
                                       2008         2007         2007
    ASSETS
    Cash                          $    82,072  $    83,840  $   149,308
    Federal funds and interest
     earning due from banks            11,060        5,900         --

     Cash and cash equivalents         93,132       89,740      149,308
    U.S. Treasury, government
     sponsored entities and other
     investment securities
     available for sale, at fair
     value                            998,457    1,549,879    1,917,603
    Loans held for sale, at lower
     of cost or fair value             85,558      103,384      187,752
    Mortgage-backed securities
     available for sale, at fair
     value                                106          111          114
    Loans held for investment      11,363,366   11,381,327   12,273,307
    Allowance for loan losses        (732,354)    (348,167)     (69,107)

     Loans held for investment,
      net                          10,631,012   11,033,160   12,204,200
    Investments in real estate and
     joint ventures                    63,182       68,679       64,997
    Real estate acquired in
     settlement of loans, net         261,536      115,623       29,925
    Premises and equipment, net       115,064      115,846      115,823
    Federal Home Loan Bank stock,
     at cost                           78,813       70,964       72,429
    Mortgage servicing rights:
     Measured at fair value            23,558         --           --
     Amortized                           --         19,512       21,619
    Other assets                      129,293      113,761      113,212
    Income tax receivable              95,505        6,312       25,988
    Deferred tax asset, net            57,103      122,086         --

                                  $12,632,319  $13,409,057  $14,902,970
                                  ===========  ===========  ===========
    LIABILITIES AND STOCKHOLDERS’
     EQUITY
    Deposits                      $ 9,880,978  $10,496,041  $11,246,806
    Securities sold under
     agreements to repurchase          97,838         --        587,544
    Federal Home Loan Bank
     advances                       1,525,034    1,197,100    1,104,373
    Senior notes                      198,543      198,445      198,351
    Accounts payable and accrued
     liabilities                       70,989      183,054      289,937
    Deferred income taxes                --           --         11,486

     Total liabilities             11,773,382   12,074,640   13,438,497

    STOCKHOLDERS’ EQUITY
    Preferred stock, par value of
     $0.01 per share; authorized
     5,000,000 shares; outstanding
     none                                --           --           --
    Common stock, par value of
     $0.01 per share; authorized
     50,000,000 shares; issued
     28,235,022 shares at Jun. 30,
     2008, Dec. 31, 2007 and
     Jun. 30, 2007; outstanding
     27,853,783 shares at Jun. 30,
     2008, Dec. 31, 2007 and
     Jun. 30, 2007                        282          282          282
    Additional paid-in capital         93,792       93,792       93,792
    Accumulated other
     comprehensive income (loss)         (304)       2,768       (6,068)
    Retained earnings                 781,959    1,254,367    1,393,259
    Treasury stock, at cost,
     381,239 shares at Jun. 30,
     2008, Dec. 31, 2007 and
     Jun. 30, 2007                    (16,792)     (16,792)     (16,792)

     Total stockholders’ equity       858,937    1,334,417    1,464,473

                                  $12,632,319  $13,409,057  $14,902,970
                                  ===========  ===========  ===========

                         DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
                        CONSOLIDATED STATEMENTS OF INCOME (LOSS)
                     (Dollars in Thousands, Except Per Share Data)

                              Three Months Ended     Six Months Ended
                                   Jun. 30,               Jun. 30,
                               2008       2007        2008       2007
    INTEREST INCOME
    Loans                   $ 161,157   $230,383   $ 338,714   $482,555
    U.S. Treasury and
     government sponsored
     entities securities       15,865     20,120      36,353     39,294
    Mortgage-backed
     securities                     3          3           6          6
    Other investment
     securities                 1,025      1,718       2,103      4,189

     Total interest income    178,050    252,224     377,176    526,044

    INTEREST EXPENSE
    Deposits                   78,893    111,888     175,321    225,463
    Federal Home Loan Bank
     advances and other
     borrowings                12,922     25,576      28,591     57,406
    Senior notes                3,304      3,301       6,608      6,602

     Total interest expense    95,119    140,765     210,520    289,471
    NET INTEREST INCOME        82,931    111,459     166,656    236,573
    PROVISION FOR CREDIT
     LOSSES                   258,874      9,505     495,744     10,122

     Net interest income
      (loss) after
      provision for credit
      losses                 (175,943)   101,954    (329,088)   226,451

    OTHER INCOME, NET
    Loan and deposit
     related fees               8,204      9,338      16,443     18,174
    Real estate and joint
     ventures held for
     investment, net           (5,271)      (111)     (5,876)       365
    Secondary marketing
     activities:
     Loan servicing income
      (loss), net               3,976       (789)      2,780     (1,225)
     Net gains on sales of
      loans and mortgage-
      backed securities         4,572      8,978       6,221     17,718
    Net gains on sales of
     investment securities       --         --           837       --
    Other                         584        109         598        181

     Total other income,
      net                      12,065     17,525      21,003     35,213

    OPERATING EXPENSE
    Salaries and related
     costs                     40,884     40,998      80,586     83,232
    Premises and equipment
     costs                      9,181      9,122      18,178     17,931
    Advertising expense           816      1,878       1,277      3,069
    Deposit insurance
     premiums and
     regulatory assessments     3,689      2,482       7,392      5,246
    Professional fees             843        731       1,146      1,290
    Impairment writedown of
     goodwill                    --         --         3,149       --
    Other general and
     administrative expense     8,974      6,201      17,454     15,996

     Total general and
      administrative
      expense                  64,387     61,412     129,182    126,764
    Net operation of real
     estate acquired in
     settlement of loans       24,139        948      48,335      1,239

     Total operating
      expense                  88,526     62,360     177,517    128,003

    INCOME (LOSS) BEFORE
     INCOME TAXES (TAX
     BENEFITS)               (252,404)    57,119    (485,602)   133,661
    Income taxes (tax
     benefits)                (33,485)    24,375     (18,986)    58,054

    NET INCOME (LOSS)       $(218,919)  $ 32,744   $(466,616)  $ 75,607
                            ==========  ========   ==========  ========

    PER SHARE INFORMATION
    Basic                   $   (7.86)  $   1.17   $  (16.75)  $   2.71
    Diluted                 $   (7.86)  $   1.17   $  (16.75)  $   2.71
    Cash dividends declared
     and paid               $    0.12   $   0.12   $    0.24   $   0.24
    WEIGHTED AVERAGE SHARES
     OUTSTANDING
    Basic                  27,853,783 27,853,783  27,853,783 27,853,783
    Diluted                27,853,783 27,884,062  27,853,783 27,884,046

                         DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
                                 SELECTED FINANCIAL DATA
                                 (Dollars in Thousands)

                           Three Months Ended        Six Months Ended
                                 Jun. 30,                 Jun. 30,
                             2008        2007        2008        2007

    NET INCOME (LOSS) BY
     BUSINESS SEGMENT
    Banking               $(215,707)    $32,614   $(462,965)    $75,037
    Real estate investment   (3,212)        130      (3,651)        570

     Total net income
      (loss)              $(218,919)    $32,744   $(466,616)    $75,607
                          ==========    =======   ==========    =======

    SELECTED FINANCIAL
     RATIOS
    Effective interest
     rate spread               2.73%       3.07%       2.68%       3.18%
    Efficiency ratio (a)      64.22       47.57       65.12       46.70
    Return on average
     assets                   (6.76)       0.87       (7.08)       0.98
    Return on average
     equity                  (85.33)       9.01      (80.67)      10.54

    ASSET AND LIABILITY
     ACTIVITY
    Loans for investment
     portfolio:
     Originations: (b)
      Residential one-to-
       four units         $ 750,578  $  698,952  $1,185,904  $1,301,850
      All other              64,765      14,876      68,147      32,376
     Repayments            (412,751) (1,489,999)   (965,693) (3,050,186)

    Loans originated for
     sale portfolio (b)     211,726     494,871     449,082   1,135,540

    Loans and mortgage-
     backed securities
     sold                  (235,113)   (569,940)   (464,100) (1,284,370)

    Decrease in loans and
     mortgage-backed
     securities              (9,189)   (817,950)   (419,979) (1,778,684)

    Decrease in assets     (499,030)   (334,899)   (776,738) (1,304,412)

    Decrease in deposits   (363,311)   (400,625)   (615,063)   (538,063)

    Increase (decrease) in
     borrowings              85,319    (153,104)    425,870    (918,748)

                                        Jun. 30,    Dec. 31,    Jun. 30,
                                          2008        2007        2007
    CAPITAL RATIOS (BANK ONLY)
    Tangible and core                      7.57%       9.98%      10.08%
    Risk-based                            14.31       19.82       20.86

    BOOK VALUE PER SHARE                 $30.84      $47.91      $52.58

    NUMBER OF BRANCHES INCLUDING
     IN-STORE LOCATIONS                     174         172         172

    (a)  The amount of general and administrative expense, excluding the
         impairment writedown of goodwill, expressed as a percentage of
         net interest income plus other income, excluding income
         associated with real estate held for investment.
    (b)  Included loans purchased.

                         DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
                          SELECTED FINANCIAL DATA - (Continued)
                                 (Dollars in Thousands)

                                        Three Months Ended Jun. 30, 2008
                                                                 Average
                                          Average                 Yield/
                                          Balance     Interest     Rate
    AVERAGE BALANCE SHEET DATA
    Interest-earning assets:
     Loans:
      Loan prepayment fees                            $  1,199     0.05%
      Write-off of deferred costs and
       premiums from loan payoffs                       (4,847)   (0.18)
      All other                                        164,805     6.10

      Total loans                       $10,804,289    161,157     5.97
     Mortgage-backed securities                 108          3     5.78
     Investment securities (a)            1,363,159     16,890     4.98

      Total interest-earnings assets     12,167,556   $178,050     5.85%
    Non-interest-earning assets             779,766

     Total assets                       $12,947,322
                                        ===========
    Transaction accounts:
     Non-interest-bearing checking (b)  $   695,040   $   --          -%
     Interest-bearing checking (b)          450,563        501     0.45
     Money market                           136,739        353     1.04
     Regular passbook                     1,021,936      2,346     0.92

      Total transaction accounts          2,304,278      3,200     0.56
    Certificates of deposit               7,747,572     75,693     3.93

     Total deposits                      10,051,850     78,893     3.16
    FHLB advances and other
     borrowings (c)                       1,547,973     12,922     3.36
    Senior notes                            198,518      3,304     6.66

     Total deposits and borrowings       11,798,341     95,119     3.24
    Other liabilities                       122,723
    Stockholders’ equity                  1,026,258

     Total liabilities and stockholders’
      equity                            $12,947,322
                                        ===========
    Net interest income/interest rate
     spread                                           $ 82,931     2.61%
                                                      ========
    Excess of interest-earning assets
     over deposits and borrowing        $   369,215
    Effective interest rate spread                                 2.73

                                        Three Months Ended Jun. 30, 2007
                                                                 Average
                                          Average                 Yield/
                                          Balance     Interest     Rate
    AVERAGE BALANCE SHEET DATA
    Interest-earning assets:
     Loans:
      Loan prepayment fees                            $ 17,591     0.55%
      Write-off of deferred costs and
       premiums from loan payoffs                      (24,325)   (0.76)
      All other                                        237,117     7.39

      Total loans                       $12,835,907    230,383     7.18
     Mortgage-backed securities                 116          3     5.92
     Investment securities (a)            1,698,378     21,838     5.16

      Total interest-earnings assets     14,534,401   $252,224     6.94%
    Non-interest-earning assets             480,034

     Total assets                       $15,014,435
                                        ===========
    Transaction accounts:
     Non-interest-bearing checking (b)  $   800,910   $   --          -%
     Interest-bearing checking (b)          486,909        382     0.31
     Money market                           145,230        376     1.04
     Regular passbook                     1,190,524      2,814     0.95

      Total transaction accounts          2,623,573      3,572     0.55
    Certificates of deposit               8,768,716    108,316     4.95

     Total deposits                      11,392,289    111,888     3.94
    FHLB advances and other
     borrowings (c)                       1,734,014     25,576     5.92
    Senior notes                            198,333      3,301     6.66

     Total deposits and borrowings       13,324,636    140,765     4.24
    Other liabilities                       235,991
    Stockholders’ equity                  1,453,808

     Total liabilities and stockholders’
      equity                            $15,014,435
                                        ===========
    Net interest income/interest rate
     spread                                           $111,459     2.70%
                                                      ========
    Excess of interest-earning assets
     over deposits and borrowing        $ 1,209,765
    Effective interest rate spread                                  3.07

                                         Six Months Ended Jun. 30, 2008
                                                                 Average
                                          Average                 Yield/
                                          Balance     Interest     Rate
    AVERAGE BALANCE SHEET DATA
    Interest-earning assets:
     Loans:
      Loan prepayment fees                            $  3,169     0.06%
      Write-off of deferred costs and
       premiums from loan payoffs                      (12,278)   (0.23)
      All other                                        347,823     6.39

      Total loans                       $10,890,484    338,714     6.22
     Mortgage-backed securities                 110          6     5.78
     Investment securities (a)            1,565,388     38,456     4.94

      Total interest-earnings assets     12,455,982   $377,176     6.06%
    Non-interest-earning assets             732,473

     Total assets                       $13,188,455
                                        ===========
    Transaction accounts:
     Non-interest-bearing checking (b)  $   673,172   $   --          -%
     Interest-bearing checking (b)          455,061      1,066     0.47
     Money market                           135,906        702     1.04
     Regular passbook                     1,027,649      4,735     0.93

      Total transaction accounts          2,291,788      6,503     0.57
    Certificates of deposit               7,908,335    168,818     4.29

     Total deposits                      10,200,123    175,321     3.46
    FHLB advances and other
     borrowings (c)                       1,479,443     28,591     3.89
    Senior notes                            198,497      6,608     6.66

     Total deposits and borrowings       11,878,063    210,520     3.56
    Other liabilities                       153,572
    Stockholders’ equity                  1,156,820

     Total liabilities and stockholders’
      equity                            $13,188,455
                                        ===========
    Net interest income/interest rate
     spread                                           $166,656     2.50%
                                                      ========
    Excess of interest-earning assets
     over deposits and borrowing        $   577,919
    Effective interest rate spread                                  2.68

                                         Six Months Ended Jun. 30, 2007
                                                                 Average
                                          Average                 Yield/
                                          Balance     Interest     Rate
    AVERAGE BALANCE SHEET DATA
    Interest-earning assets:
     Loans:
      Loan prepayment fees                            $ 39,395     0.59%
      Write-off of deferred costs and
       premiums from loan payoffs                      (50,139)   (0.75)
      All other                                        493,299     7.44

      Total loans                       $13,257,340    482,555     7.28
     Mortgage-backed securities                 134          6     5.89
     Investment securities (a)            1,638,663     43,483     5.35

      Total interest-earnings assets     14,896,137   $526,044     7.06%
    Non-interest-earning assets             474,773

     Total assets                       $15,370,910
                                        ===========
    Transaction accounts:
     Non-interest-bearing checking (b)  $   777,986   $   --          -%
     Interest-bearing checking (b)          487,542        777     0.32
     Money market                           147,807        761     1.04
     Regular passbook                     1,217,173      5,763     0.95

      Total transaction accounts          2,630,508      7,301     0.56
    Certificates of deposit               8,886,450    218,162     4.95

     Total deposits                      11,516,958    225,463     3.95
    FHLB advances and other
     borrowings (c)                       1,980,803     57,406     5.84
    Senior notes                            198,311      6,602     6.66

     Total deposits and borrowings       13,696,072    289,471     4.26
    Other liabilities                       239,531
    Stockholders’ equity                  1,435,307

     Total liabilities and stockholders’
      equity                            $15,370,910
                                        ===========
    Net interest income/interest rate
     spread                                           $236,573     2.80%
                                                      ========
    Excess of interest-earning assets
     over deposits and borrowing        $ 1,200,065
    Effective interest rate spread                                  3.18

    (a)  Yields for securities available for sale are calculated using
         historical cost balances and are not adjusted for changes in
         fair value that are reflected as a separate component of
         stockholders’ equity.
    (b)  Included amounts swept into money market deposit accounts.
    (c)  The impact of interest rate swap contracts was included, with
         notional amounts totaling $430 million of receive-fixed, pay-
         3-month London Inter-Bank Offered Rate ("LIBOR") variable
         interest, which contracts serve as a permitted hedge against a
         portion of our FHLB advances.

                         DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
                          SELECTED FINANCIAL DATA - (Continued)
                                 (Dollars in Thousands)

                               Three Months Ended     Six Months Ended
                                     Jun. 30,              Jun. 30,
                                 2008       2007       2008        2007
    LOAN AND DEPOSIT RELATED
     FEES
    Loan related fees          $   377    $   819    $   799     $ 1,661
    Deposit related fees:
     Automated teller machine
      fees                       1,859      2,440      3,856      4,745
     Other fees                  5,968      6,079     11,788     11,768

     Total loan and deposit
      related fees             $ 8,204    $ 9,338    $16,443    $18,174
                               =======    =======    =======    =======
    NET GAINS ON SALES OF LOANS
     AND MORTGAGE-BACKED
     SECURITIES
    Mortgage servicing rights  $ 1,557    $ 1,926    $ 2,679    $ 3,267
    All other components
     excluding SFAS 133            916      6,186      1,512     13,334
    SFAS 133                     2,099        866      2,030      1,117

     Total net gains on sales
      of loans and mortgage-
      backed securities        $ 4,572    $ 8,978    $ 6,221    $17,718
                               =======    =======    =======    =======
    Secondary marketing gain
     excluding SFAS 133 as a
     percentage of associated
     sales                        1.05%      1.42%      0.90%      1.29%

    LOAN SERVICING INCOME
     (LOSS), NET
    Net cash servicing fees    $ 1,750    $ 1,598    $ 3,515    $ 3,205
    Payoff and curtailment
     interest cost (a)            (350)    (1,391)      (821)    (2,454)
    Change in fair value of
     mortgage servicing
     rights due to: (b)
     Changes in valuation
      model inputs or
      assumptions (c)            3,325      --         1,574       --
     Other changes (d)            (749)     --        (1,488)      --
    Amortization of mortgage
     servicing rights             --        (967)        --      (1,991)
    (Provision for) reduction
     of impairment of mortgage
     servicing rights             --         (29)        --          15

     Total loan servicing
      income (loss), net       $ 3,976    $  (789)   $ 2,780    $(1,225)
                               =======    =======    =======    =======
    MORTGAGE SERVICING RIGHTS
     ACTIVITY
    Balance at beginning of
     period                    $19,425    $20,871    $21,973    $21,435
    Remeasurement of mortgage
     servicing rights to fair
     value (b)                    --         --         (918)      --

     Adjusted balance at
      beginning of period       19,425     20,871     21,055     21,435

    Additions (e)                1,557      1,926      2,679      3,267
    Amortization                  --         (967)      --       (1,991)
    Sales                         --         --         (262)      (868)
    Impairment write-down         --         (123)      --         (136)
    Changes in fair value due
     to:
     Changes in valuation
      model inputs or
      assumptions (c)            3,325       --        1,574       --
     Other changes (d)            (749)      --       (1,488)      --

     Balance at end of period   23,558     21,707     23,558     21,707

    Allowance balance at
     beginning of period          --          182      2,461        239
    Remeasurement of mortgage
     servicing rights to fair
     value                        --         --      (2,461)       --

     Adjusted balance at
      beginning of period         --          182      --           239

    Provision for (reduction
     of) impairment               --           29      --           (15)
    Impairment write-down         --         (123)     --          (136)

     Allowance balance at end
      of period                   --           88      --            88

      Total mortgage servicing
       rights, net             $23,558    $21,619    $23,558    $21,619
                               =======    =======    =======    =======
    As a percentage of
     associated mortgage loans    0.95%      0.91%      0.95%      0.91%
    Fair value (f)             $23,558    $25,080    $23,558    $25,080
    Weighted average expected
     life (in months)               69         65         69         65
    Custodial account earnings
     rate                         3.75%      5.35%      3.75%      5.35%
    Weighted average discount
     rate                        11.78      10.13      11.78      10.13

                                   Jun. 30,     Dec. 31,      Jun. 30,
    (Dollars in Thousands)           2008         2007          2007
    MORTGAGE LOANS SERVICED FOR
     OTHERS
    Total                        $5,435,529    $5,525,357    $6,002,907
    With capitalized mortgage
     servicing rights: (f)
     Amount                       2,471,000     2,436,278     2,383,290
     Weighted average interest
      rate                             5.87%         5.88%         5.79%
    Total loans sub-serviced
     without mortgage servicing
     rights: (g)
     Term - less than six months $  103,972    $   81,123    $  398,530
     Term - indefinite            2,857,191     2,995,119     3,207,087
    Custodial account balances   $   67,710    $   81,778    $  156,433

    (a)  Represents the difference between the contractual obligation to
         pay interest to the investor for an entire month and the actual
         interest received when a loan prepays prior to the end of the
         month.  However, loan servicing activities do not include the
         benefit of the use of total loan repayments to increase net
         interest income.
    (b)  Effective January 1, 2008, Downey adopted the fair value
         provision of Statement of Financial Accounting Standards No.
         156, Accounting for Servicing of Financial Assets - an
         amendment of FASB Statement No. 140 ("SFAS 156") and remeasured
         its mortgage servicing rights ("MSRs") at fair value.  Downey
         recorded a pretax adjustment to increase MSRs by $1.5 million
         and a corresponding cumulative effect adjustment of
         $0.9 million, after tax, to increase the 2008 beginning balance
         of retained earnings in stockholders’ equity.
    (c)  Reflects changes in assumptions for discount rates, prepayment
         speeds, etc.
    (d)  Represents changes due to realization of expected cash flows
         over time.
    (e)  Included minor amounts repurchased.
    (f)  Excludes loans sub-serviced without capitalized mortgage
         servicing rights.  The estimated fair values for periods
         presented prior to 2008 may exceed book value for certain asset
         strata and excluded loans sold or securitized prior to 1996.
    (g)  Servicing is performed for a fixed fee per loan each month.

                         DOWNEY FINANCIAL CORP. AND SUBSIDIARIES
                          SELECTED FINANCIAL DATA  (Continued)
                                 (Dollars in Thousands)

                                  Jun. 30,      Dec. 31,       Jun. 30,
                                    2008          2007           2007
    LOANS HELD FOR INVESTMENT
    Loans secured by real
     estate:
     Residential one-to-four
      units                     $10,894,889   $10,877,228   $11,714,635
     Home equity loans and lines
      of credit                     131,531       138,305       154,980
     Residential five or more
      units                         121,403       100,963       108,302
     Commercial real estate          22,633        26,427        26,767
     Construction                   105,991        81,098        52,699
     Land                            10,524        49,521        64,262
    Non-mortgage:
     Commercial                       5,505         5,000         2,700
     Consumer                         5,823         5,989         6,346

     Total loans held for
      investment                 11,298,299    11,284,531    12,130,691
    Increase (decrease) for:
     Undisbursed loan funds and
      net deferred costs and
      premiums                       65,067        96,796       142,616
     Allowance for losses          (732,354)     (348,167)      (69,107)

      Total loans held for
       investment, net          $10,631,012   $11,033,160   $12,204,200
                                ===========   ===========   ===========
    LOANS HELD FOR SALE
    Residential one-to-four
     units                      $    85,854   $   103,320   $   189,189
    Net deferred costs and
     premiums                          (146)         (109)          285
    Capitalized basis
     adjustment (a)                    (150)          173        (1,722)

     Total loans held for sale,
      net                       $    85,558   $   103,384   $   187,752
                                ===========   ===========   ===========
    RESIDENTIAL ONE-TO-FOUR UNIT
     LOANS SUBJECT TO NEGATIVE
     AMORTIZATION
    Held for investment:
     Amount                     $ 6,242,406   $ 7,530,590   $ 8,914,448
     Amount as a percentage of
      total residential one-to-
      four unit loans                    57%           69%           76%
     Negative amortization
      included in the loan
      balance                       344,376       378,664       377,327
     Negative amortization as a
      percentage of the
      associated loan balance          5.52%         5.03%         4.23%

    NON-PERFORMING ASSETS
    Non-accrual loans:
     Residential one-to-four
      units:
      Performing troubled debt
       restructurings (b)       $   548,096   $   400,562   $      --
      Other troubled debt
       restructurings               240,220        31,218          --
      All other                     894,659       448,516       178,504
     Construction                    12,790        15,933         7,067
     Land                              --          29,080        11,345
     Other                              566           837           525

      Total non-accrual loans     1,696,331       926,146       197,441
    Real estate acquired in
     settlement of loans            261,536       115,623        29,925

     Total non-performing
      assets                    $ 1,957,867   $ 1,041,769   $   227,366
                                ===========   ===========   ===========
    Non-performing assets as a
     percentage of total assets:
     Performing troubled debt
      restructurings (b)               4.34%         2.99%            -%
     All other non-performing
      assets                          11.16          4.78          1.53
      Total non-performing
       assets as a percentage of
       total assets                   15.50%         7.77%         1.53%
                                      ======         =====         =====
    DELINQUENT LOANS
    30-59 days                  $   269,658   $   239,338   $    77,527
    60-89 days                      209,615       135,177        57,076
    90+ days (c)                    796,924       314,365       125,283
     Total delinquent loans     $ 1,276,197   $   688,880   $   259,886
                                ===========   ===========   ===========
    Delinquencies as a
     percentage of total loans        11.21%         6.05%         2.11%

    (a)  Reflected the change in fair value of the interest rate lock
         derivative from the date of rate lock to the date of funding.
    (b)  Represents troubled debt restructurings (TDRs) associated with
         Downey’s borrower retention program wherein all loan payments
         were current and interest rates were modified to no less than
         that offered new borrowers at the time of loan modification.
         These TDR loans will be on non-accrual status until six
         consecutive months of successful payment history has been
         established, at which time they will be removed from non-
         accrual status and will no longer be reported as non-performing
         assets, just TDRs.
         Interest income is being recognized on these TDR loans as paid
         on a cash basis.
    (c)  All 90 day or greater delinquencies are on non-accrual status
         and reported as part of non-performing assets.
    Note:  Certain prior period amounts have been reclassified to
           conform to the current presentation.


SOURCE Downey Financial Corporation

http://www.downeysavings.com 


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