AUSTIN, Texas — When Guaranty Financial Group Inc. was spun off from Temple-Inland Inc. at the end of 2007, the new company told investors that the future looked bright.
The company said in its first annual report that it was "charting a new course toward a future full of opportunity."
Now 19 months later, Guaranty is on the verge of financial collapse and awaiting a takeover by regulators.
So what happened?
The answer to that question is that for a period of years, Guaranty made very big bets on lending to homebuilders and homebuyers in California and in investing in securities backed by pools of home mortgages.
When the nation's real estate boom was going strong, those looked like profitable bets.
But when real estate markets weakened in early 2008, those bets turned into big losers for Guaranty, one of the largest Texas-based financial institutions.
The company reported losses of at least $444 million in 2008, and estimated it lost another $256 million in the first quarter of this year.
More losses will be coming this year, as Guaranty accounts for the severely diminished value of its mortgage-backed securities.
Those securities might have looked attractive at one time, but now they don't.
"The reality is, they were not safe," said Dan Bass, Houston managing director of Carson Medlin Co., an investment banking firm. "The underlying mortgages went bad."
Many of the underlying loans were made by lenders such as Countrywide Financial Corp. and Washington Mutual Bank, which failed last year.
And many of those loans were so-called pay-option ARMs, a type of adjustable rate mortgage that lets borrowers make minimal monthly payments or pay only the interest.
Financial experts say such loans can be very risky at a time of falling real estate values.
Bass said many of the securities were backed by loans made to homebuyers who got in over their heads.
As the housing crisis grew, home values began to fall and buyers began to default on their mortgages, and those securities dropped in value.
Guaranty reported that its mortgage securities were worth more than $3 billion at the end of 2006, and $2.2 billion at the end of March of this year.
But this month, regulators said the securities weren't worth anywhere near that much, and ordered Guaranty to cut their value by $1.5 billion.
That move pushed the bank's finances into a critical condition, and triggered its announcement last week that a takeover was imminent.
Last year, as the housing crisis deepened, Guaranty also suffered because a high percentage of its own mortgage loans — including pay-option ARMs — had been made to buyers in California, where the housing crisis was most severe. The company had loan offices in cities such as Riverside and Stockton, which have some of the highest foreclosure rates in the country.
Guaranty had an equal problem with loans to homebuilders in that state. As of Sept. 30, almost 40 percent of its nonperforming builder loans were in California.
Late last year, Guaranty acknowledged in securities filings that its nonperforming assets — problem loans and foreclosed property — had tripled to $520 million from the start of the year.
As its finances deteriorated, Guaranty responded by raising more capital. In June, billionaires Carl Icahn and Robert Rowling invested a combined $600 million in the company.
Rowling got a seat on the company's board, and became Guaranty's biggest shareholder, with 19.9 percent of its stock.
It wasn't enough. On April 6, the Office of Thrift Supervision laid down the law: Guaranty had to raise even more capital, find a buyer or face a takeover. The regulator said Guaranty had engaged in "unsafe and unsound banking practices."
After months of trying to find a rescue plan, the company on Thursday essentially threw in the towel.
It said its major shareholders would not put in more money and that Guaranty had become "critically undercapitalized" because of the slashed value of its mortgage-backed securities.
"That was the straw that broke the camel's back," said Jim Gardner, chairman of Dallas-based Commerce Street Capital.
In its Thursday filing, Guaranty said that regulators had essentially taken over functions of its board of directors.
"They have taken over without (officially) taking over," Gardner said.
Because of that, regulators might have a little more time to find someone to buy Guaranty's assets, he said. "They can now negotiate with various buyers."
Meanwhile, some customers have made their own decision about Guaranty.
Christopher Williston, president of the Independent Bankers Association of Texas, said that several bankers have told him they are seeing significant deposits coming into their banks from Guaranty customers.
"Those who have been waiting to get around to it, are getting around to it today," he said.
Kirk Ladendorf and Tim Eaton write for the Austin American-Statesman. E-mail: kladendorf(at)statesman.com.