UPDATE 1-Downey to cease wholesale lending; cut 200 jobs

(Recasts; adds details, background) Oct 16 (Reuters) - Struggling lender Downey Financial Corp DSL.N said it would cease to operate its wholesale lending channel and the loan processing centers supporting it, affecting about 200 jobs.

The California-based lender also said it was scaling back on its retail lending and will contract its retail loan department to reflect industry-wide contraction in retail lending.

Downey, one of the few large lenders remaining who originate option adjustable-rate mortgages, has struggled in the past losing $218.9 million in the second quarter.

The company has been trying hard to enhance its financial strength by the year end and sold certain real estate assets last month, after being clamped down by federal authorities.

Option ARMs allowed borrowers to pay less than the interest and principal due each month. Many borrowers are defaulting on these loans, often finding themselves owing more than their homes are worth.

Downey Savings and Loan, the company's primary subsidiary, has assets of $13.9 billion and operates 170 branches throughout California and five in Arizona.

Shares of the company were trading at $2.06 on the New York Stock Exchange.

(Reporting by Supantha Mukherjee in Bangalore)