![]() |
||||||||||||||||||||||||||
![]() | SEC Info ![]() | ![]() | ![]() | Home | ![]() | ![]() | Search | ![]() | ![]() | My Interests | ![]() | ![]() | Help | ![]() | ![]() | Sign In | ![]() | ![]() | Please Sign In | |||||||
![]() |
As Of Filer Filing For·On·As Docs:Size Issuer Agent 5/12/08 Indymac Bancorp Inc 10-Q 3/31/08 5:2.3M Merrill Corp/New/FA |
Document/Exhibit Description Pages Size 1: 10-Q Quarterly Report HTML 1.80M 2: EX-31.1 Certification per Sarbanes-Oxley Act (Section 302) HTML 12K 3: EX-31.2 Certification per Sarbanes-Oxley Act (Section 302) HTML 11K 4: EX-32.1 Certification per Sarbanes-Oxley Act (Section 906) HTML 8K 5: EX-32.2 Certification per Sarbanes-Oxley Act (Section 906) HTML 8K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
ý | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the quarterly period ended March 31, 2008 |
||
or |
||
o |
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
|
For the transition period from to |
||
Commission file number 1-8972 |
INDYMAC BANCORP, INC.
(Exact name of registrant as specified in its charter)
Delaware | 95-3983415 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) | |
888 East Walnut Street, Pasadena, California |
91101-7211 |
|
(Address of principal executive offices) | (Zip Code) | |
(Registrant's telephone number, including area code) (800) 669-2300 |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer", "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ý | Accelerated filer o | Non-accelerated filer o (Do not check if smaller reporting company) |
Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Common stock outstanding as of May 6, 2008: 100,888,469 shares
INDYMAC BANCORP, INC.
FORM 10-Q QUARTERLY REPORT
For the Quarter Ended March 31, 2008
|
|
Page |
||
---|---|---|---|---|
PART I. FINANCIAL INFORMATION | ||||
Forward-Looking Statements |
3 |
|||
Item 2. | Management's Discussion and Analysis of Financial Condition and Results of Operations | 3 | ||
Overview and Narrative Summary of Consolidated Financial Results | 3 | |||
Selected Consolidated Financial Highlights | 6 | |||
Summary of Business Segment Results | 8 | |||
Mortgage Banking Segment | 10 | |||
Mortgage Production Division | 12 | |||
Mortgage Servicing Division | 17 | |||
Thrift Segment | 20 | |||
Mortgage-Backed Securities Division | 22 | |||
SFR Mortgage Loans HFI Division | 23 | |||
Consumer Construction Division | 24 | |||
Eliminations & Other Segment | 25 | |||
Corporate Overhead Segment | 26 | |||
Discontinued Business Activities | 26 | |||
Consolidated Risk Management Discussion | 30 | |||
CAMELS Framework For Risk Management | 30 | |||
Capital | 31 | |||
Asset Quality | 35 | |||
Management | 43 | |||
Earnings | 43 | |||
Liquidity | 44 | |||
Sensitivity to Market Risk | 48 | |||
Expenses | 54 | |||
Prospective Trends and Future Outlook | 55 | |||
Off-Balance Sheet Arrangements | 56 | |||
Aggregate Contractual Obligations | 56 | |||
Critical Accounting Policies and Judgments | 57 | |||
Other Considerations | 59 | |||
Appendix A: Additional Quantitative Disclosures | 60 | |||
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 71 | ||
Item 4. | Controls and Procedures | 71 | ||
Item 1. | Financial Statements (Unaudited) | 72 | ||
Consolidated Balance Sheets | 72 | |||
Consolidated Statements of Operations | 73 | |||
Consolidated Statements of Changes in Shareholders' Equity and Comprehensive Income (Loss) | 74 | |||
Consolidated Statements of Cash Flows | 75 | |||
Notes to Consolidated Financial Statements | 76 | |||
PART II. OTHER INFORMATION |
||||
Item 1. |
Legal Proceedings |
86 |
||
Item 1A. | Risk Factors | 86 | ||
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 88 | ||
Item 6. | Exhibits | 89 | ||
Signature | 90 |
2
Certain statements contained in this Form 10-Q may be deemed to be forward-looking statements within the meaning of the federal securities laws. Examples include forecasts of continued declines in credit costs and overall losses for the remainder of 2008, the anticipation that the deferral/suspension of the interest/dividends will be temporary, improving capital ratios and our expectation to remain well-capitalized. Words such as "anticipate," "believe," "estimate," "expect," "project," "plan," "forecast," "intend," "goal," "target," and similar expressions, as well as future or conditional verbs, such as "will," "would," "should," "could," or "may," identify forward-looking statements that are inherently subject to risks and uncertainties, many of which cannot be predicted or quantified. Actual results and the timing of certain events could differ materially from those projected in or contemplated by the forward-looking statements due to a number of factors, including: the effect of economic and market conditions including, but not limited to, recent disruptions in the housing and credit markets, including the level of housing prices, industry volumes and margins; the level and volatility of interest rates; Indymac's hedging strategies, hedge effectiveness and overall asset and liability management; the accuracy of subjective estimates used in determining the fair value of financial assets of Indymac; the implementation of new accounting pronouncements and guidance; the various credit risks associated with our loans and other financial assets, including increased credit losses due to demand trends in the economy and the real estate market and increased delinquency rates of borrowers; the adequacy of credit reserves and the assumptions underlying them; the actions undertaken by both current and potential new competitors; the availability of funds from Indymac's lenders (in particular, the Federal Home Loan Bank), loan sales, securitizations, deposits and all other sources used to fund mortgage loan originations and portfolio investments; and the execution of Indymac's business and growth plans and its ability to gain market share in a significant and turbulent market transition. Additional risk factors include the impact of disruptions triggered by natural disasters; pending or future legislation, regulations and regulatory action, or litigation, and factors described in the reports that Indymac files with the Securities and Exchange Commission ("SEC"), including its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, and its reports on Form 8-K. For further information on our risk factors, please refer to "Risk Factors" on pages 68 to 77 in Indymac's annual report on Form 10-K for the year ended December 31, 2007 ("2007 Form 10-K") and Part II. Item 1A. "Risk Factors" of this Form 10-Q. Indymac does not undertake to update or revise forward-looking statements to reflect the impact of circumstances for events that arise after the date the forward-looking statements are made.
References to "IndyMac Bancorp" or the "Parent Company" refer to the parent company alone, while references to "Indymac," the "Company," or "we" refer to the parent company and its consolidated subsidiaries. References to "Indymac Bank" or the "Bank" refer to our subsidiary, IndyMac Bank, F.S.B., and its consolidated subsidiaries.
The following discussion addresses the Company's financial condition and results of operations for the three months ended March 31, 2008.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW AND NARRATIVE SUMMARY OF CONSOLIDATED FINANCIAL RESULTS
The unprecedented ongoing disruption in the U.S. housing and mortgage markets continued throughout the first quarter of 2008. These negative trends included increased mortgage delinquencies and foreclosures, accelerating declines in home prices, and significantly wider credit spreads on mortgage-backed securities, and had an adverse impact on our financial results this quarter. Although these trends combined with our business model that is solely focused on home lending resulted in our recording a net loss of $184 million for the first quarter of 2008, this loss is down 64% from the fourth quarter of 2007.
3
This declining loss reflects $249 million pre-tax in credit costs during the quarter, a 71% reduction from $863 million in the fourth quarter of last year. Additionally, the Company incurred a nonrecurring restructuring charge of $72 million in the first quarter of 2008 to right-size our costs to the current environment. Furthermore, we recorded net losses of $66 million on our mortgage-backed securities ("MBS") trading portfolio during the quarter primarily due to the non-agency mortgage-backed securities credit spread widening. These losses are unrealized and we believe are a result of reduced liquidity in the currently disrupted market for these bonds and that actual realized losses will be much lower. As a result, we expect to substantially recover these losses over time as we have the ability and intent to hold the securities to recovery or maturity.
Given this worsening state of the industry, Indymac has intensified its efforts in maintaining strong capital and liquidity positions, which included primarily focusing on being a profitable government-sponsored entities ("GSE") lender, as this presently remains the only reliable secondary market; tightening lending standards to enhance credit quality of current loan production; implementing credit loss prevention and mitigation strategies on mortgage loans; capital raising activities; initiating cost reduction measures; and improving customer service.
Other significant items affecting first quarter of 2008 results include the following:
Second, the regulations require us to exclude from our Tier 2 capital the portion of our allowance for loan losses (ALL) that exceeds the 1.25% of risk-weighted assets limitation. If we were further allowed to include in Tier 2 capital our ALL that exceeds 1.25% of our risk-weighted assets, our capital ratios would be 6.07% Tier 1 core, 9.47% Tier 1 risk-based and 11.36% total risk-based.
4
5
SELECTED CONSOLIDATED FINANCIAL HIGHLIGHTS
The following highlights our consolidated financial condition and results of operations for the periods indicated (dollars in millions, except per share data):
|
Three Months Ended |
|||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
March 31, 2008 |
December 31, 2007 |
September 30, 2007 |
June 30, 2007 |
March 31, 2007 |
|||||||||||
Balance Sheet Information (at period end)(1) | ||||||||||||||||
Cash and cash equivalents |
$ |
808 |
$ |
562 |
$ |
785 |
$ |
618 |
$ |
577 |
||||||
Securities (trading and available for sale) | 6,619 | 7,328 | 5,732 | 5,608 | 5,253 | |||||||||||
Loans held for sale (includes $2,411 carried at fair value at March 31, 2008) | 3,325 | 3,775 | 14,040 | 11,764 | 10,514 | |||||||||||
Loans held for investment | 16,726 | 16,497 | 8,553 | 8,648 | 8,988 | |||||||||||
Allowance for loan losses | (483 | ) | (398 | ) | (162 | ) | (77 | ) | (68 | ) | ||||||
Mortgage servicing rights | 2,560 | 2,495 | 2,490 | 2,387 | 2,053 | |||||||||||
Other assets | 2,750 | 2,475 | 2,295 | 2,711 | 2,377 | |||||||||||
Total Assets | $ | 32,305 | $ | 32,734 | $ | 33,733 | $ | 31,659 | $ | 29,694 | ||||||
Deposits | $ | 18,938 | $ | 17,815 | $ | 16,775 | $ | 11,747 | $ | 11,452 | ||||||
Advances from Federal Home Loan Bank | 10,359 | 11,189 | 11,095 | 10,873 | 10,350 | |||||||||||
Other borrowings | 633 | 652 | 2,189 | 4,527 | 4,313 | |||||||||||
Other liabilities and preferred stock in subsidiary | 1,416 | 1,734 | 1,803 | 2,462 | 1,525 | |||||||||||
Total Liabilities and Preferred Stock in Subsidiary | $ | 31,346 | $ | 31,390 | $ | 31,862 | $ | 29,609 | $ | 27,639 | ||||||
Shareholders' Equity | $ | 959 | $ | 1,344 | $ | 1,871 | $ | 2,050 | $ | 2,055 | ||||||
Statement of Operations Information(1) | ||||||||||||||||
Net interest income |
$ |
111 |
$ |
140 |
$ |
142 |
$ |
149 |
$ |
135 |
||||||
Provision for loan losses | (132 | ) | (269 | ) | (98 | ) | (17 | ) | (11 | ) | ||||||
Gain (loss) on sale of loans(2) | 92 | (322 | ) | (251 | ) | 101 | 118 | |||||||||
Service fee income | 193 | 171 | 213 | 86 | 49 | |||||||||||
Loss on mortgage-backed securities ("MBS") | (160 | ) | (294 | ) | (94 | ) | (46 | ) | (5 | ) | ||||||
Fee and other income(2) | 39 | 20 | 46 | 25 | 16 | |||||||||||
Net revenues (loss) | 143 | (554 | ) | (42 | ) | 298 | 302 | |||||||||
Operating expenses(2) | (316 | ) | (231 | ) | (231 | ) | (220 | ) | (214 | ) | ||||||
Restructuring/severance charges | (72 | ) | (4 | ) | (28 | ) | — | — | ||||||||
REO related expenses | (47 | ) | (30 | ) | (11 | ) | (4 | ) | (2 | ) | ||||||
Minority interests | (10 | ) | (10 | ) | (13 | ) | — | — | ||||||||
(Provision) benefit for income taxes | 118 | 320 | 122 | (29 | ) | (34 | ) | |||||||||
Net earnings (loss) | $ | (184 | ) | $ | (509 | ) | $ | (203 | ) | $ | 45 | $ | 52 | |||
Operating Data | ||||||||||||||||
SFR mortgage loan production |
$ |
9,591 |
$ |
12,089 |
$ |
16,816 |
$ |
22,505 |
$ |
25,569 |
||||||
Total loan production(3) | 9,712 | 12,301 | 17,062 | 23,023 | 25,930 | |||||||||||
Mortgage industry market share(4) | 1.70 | % | 2.62 | % | 3.02 | % | 3.27 | % | 4.08 | % | ||||||
Pipeline of SFR mortgage loans in process (at period end) | $ | 5,107 | $ | 7,506 | $ | 7,421 | $ | 13,376 | $ | 16,112 | ||||||
Loans sold | 9,920 | 13,425 | 13,009 | 20,194 | 24,537 | |||||||||||
Loans sold/SFR mortgage loan production | 103 | % | 111 | % | 77 | % | 90 | % | 96 | % | ||||||
SFR mortgage loans serviced for others (at period end)(5) | $ | 184,535 | $ | 181,724 | $ | 173,915 | $ | 167,710 | $ | 156,144 | ||||||
Total SFR mortgage loans serviced (at period end) | 200,696 | 198,170 | 192,629 | 183,574 | 171,955 | |||||||||||
Average number of full-time equivalent employees ("FTEs") | 8,169 | 9,994 | 9,890 | 9,431 | 8,755 | |||||||||||
Per Common Share Data |
||||||||||||||||
Basic earnings (loss) per share(6) |
$ |
(2.27 |
) |
$ |
(6.43 |
) |
$ |
(2.77 |
) |
$ |
0.62 |
$ |
0.72 |
|||
Diluted earnings (loss) per share(7) | (2.27 | ) | (6.43 | ) | (2.77 | ) | 0.60 | 0.70 | ||||||||
Dividends declared per share | — | 0.25 | 0.50 | 0.50 | 0.50 | |||||||||||
Dividend payout ratio(8) | N/M | (4 | )% | (18 | )% | 83 | % | 71 | % | |||||||
Book value per share (at period end)(9) | $ | 14.00 | $ | 16.61 | $ | 24.31 | $ | 27.83 | $ | 27.93 | ||||||
Closing price per share (at period end) | 4.96 | 5.95 | 23.61 | 29.17 | 32.05 | |||||||||||
Average Shares (in thousands): | ||||||||||||||||
Basic | 81,177 | 79,139 | 73,134 | 72,412 | 72,297 | |||||||||||
Diluted | 81,177 | 79,139 | 73,134 | 73,976 | 74,305 | |||||||||||
Performance Ratios |
||||||||||||||||
Return on equity ("ROE") |
(57.09 |
)% |
(115.74 |
)% |
(39.15 |
)% |
8.62 |
% |
10.45 |
% |
||||||
Return on assets ("ROA") | (2.15 | )% | (5.63 | )% | (2.18 | )% | 0.50 | % | 0.60 | % | ||||||
Net interest margin, consolidated | 1.51 | % | 1.80 | % | 1.78 | % | 1.92 | % | 1.77 | % | ||||||
Net interest margin, thrift(10) | 2.09 | % | 2.33 | % | 2.27 | % | 2.09 | % | 1.88 | % | ||||||
Mortgage banking revenue ("MBR") margin on loans sold(11)(2) | 1.03 | % | (2.18 | )% | (1.54 | )% | 0.80 | % | 0.68 | % | ||||||
Efficiency ratio(12) | 115 | % | (81 | )% | 414 | % | 70 | % | 68 | % | ||||||
Operating expenses to total loan production | 3.24 | % | 1.88 | % | 1.36 | % | 0.95 | % | 0.82 | % | ||||||
Average Balance Sheet Data and Asset Quality Ratios |
||||||||||||||||
Average interest-earning assets |
$ |
29,490 |
$ |
30,945 |
$ |
31,695 |
$ |
31,255 |
$ |
31,030 |
||||||
Average assets | 34,312 | 35,851 | 36,833 | 35,837 | 35,341 | |||||||||||
Average equity | 1,295 | 1,745 | 2,054 | 2,078 | 2,033 | |||||||||||
Debt to equity ratio (at period end)(13) | 20.6:1 | 16.2:1 | 12.7:1 | 10.7:1 | 12.7:1 | |||||||||||
Tier 1 (core) capital ratio (at period end)(14) | 5.74 | % | 6.24 | % | 7.48 | % | 8.10 | % | 7.41 | % | ||||||
Total risk-based capital ratio (at period end)(14) | 10.26 | % | 10.81 | % | 12.01 | % | 12.24 | % | 11.37 | % | ||||||
Non-performing assets to total assets (at period end)(15) | 6.51 | % | 4.61 | % | 2.46 | % | 1.63 | % | 1.09 | % | ||||||
Allowance for loan losses to total loans held for investment (at period end)(16) | 5.76 | % | 5.29 | % | 1.89 | % | 0.89 | % | 0.75 | % | ||||||
Allowance for loan losses to non-performing loans held for investment (at period end)(17) | 52.14 | % | 66.67 | % | 47.64 | % | 36.07 | % | 44.11 | % |
6
The following non-GAAP information presents the impact of the discussion above (in millions):
|
Three Months Ended |
||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
March 31, 2008 |
December 31, 2007 |
September 30, 2007 |
June 30, 2007 |
March 31, 2007 |
||||||||||
Gain (loss) on sale of loans, as reported | $ | 92 | $ | (322 | ) | $ | (251 | ) | $ | 101 | $ | 118 | |||
As-if effect of deferring income under SFAS 91 | 12 | — | — | — | — | ||||||||||
As-if effect of deferring expenses under SFAS 91 | (46 | ) | — | — | — | — | |||||||||
Broker premium recorded due to SFAS 159 adoption beginning January 1, 2008 | (58 | ) | — | — | — | — | |||||||||
Revenue recorded for the first quarter of 2008 due to SAB 109 adoption | (18 | ) | — | — | — | — | |||||||||
$ | (18 | ) | $ | (322 | ) | $ | (251 | ) | $ | 101 | $ | 118 | |||
Fee and other income, as reported |
$ |
39 |
$ |
20 |
$ |
46 |
$ |
25 |
$ |
16 |
|||||
As-if effect of deferring income under SFAS 91 | (12 | ) | — | — | — | — | |||||||||
$ | 27 | $ | 20 | $ | 46 | $ | 25 | $ | 16 | ||||||
Operating expenses, as reported |
$ |
316 |
$ |
231 |
$ |
231 |
$ |
220 |
$ |
214 |
|||||
As-if effect of deferring expenses under SFAS 91 | (46 | ) | — | — | — | — | |||||||||
Broker premium recorded due to SFAS 159 adoption beginning January 1, 2008 | (58 | ) | — | — | — | — | |||||||||
$ | 212 | $ | 231 | $ | 231 | $ | 220 | $ | 214 | ||||||
Net MBR margin, as reported (in bps based on loans sold) |
103 |
(218 |
) |
154 |
80 |
68 |
|||||||||
As-if effect of deferring income under SFAS 91 (in bps based on loans sold) | 12 | — | — | — | — | ||||||||||
As-if effect of deferring expenses under SFAS 91 (in bps based on loans sold) | (46 | ) | — | — | — | — | |||||||||
Broker premium recorded due to SFAS 159 adoption beginning January 1, 2008 (in bps based on loans sold) | (58 | ) | — | — | — | — | |||||||||
Revenue recorded for the first quarter of 2008 due to SAB 109 adoption (in bps based on loans sold) | (18 | ) | — | — | — | — | |||||||||
(7 | ) | (218 | ) | 154 | 80 | 68 | |||||||||
7
SUMMARY OF BUSINESS SEGMENT RESULTS
Our segment reporting is organized consistent with our hybrid mortgage banking/thrift business model. Mortgage banking involves the origination, securitization and sale of mortgage loans and related assets, and the servicing of those loans. The revenues from mortgage banking consist primarily of gains on the sale of the loans, fees earned from origination, net interest income earned while the loans are held pending sale, and servicing fees. On the thrift side, we generate core spread income from our investment portfolio of prime SFR mortgage loans, MBS and consumer construction loans.
As conditions in the U.S. mortgage market have deteriorated, we exited certain production channels in the fourth quarter of 2007 and are reporting them in a separate category in our segment reporting, "Discontinued Business Activities". These exited production channels include the conduit, homebuilder and home equity channels. These activities are not considered discontinued operations as defined by Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), due to our significant continuing involvement in these activities. We segregated the business activities we have exited so that the mortgage and thrift segments presented represent our new business model. See the "Discontinued Business Activities and Restructuring Charges" section for more information.
We have developed a detailed reporting process that computes net earnings and ROE for our key business segments each reporting period, and we use the results to evaluate our managers' performance. In addition, we use the results to evaluate the performance and prospects of our divisions and adjust our capital allocations to those that earn the best returns for our shareholders.
We predominantly use U.S. Generally Accepted Accounting Principles ("GAAP") to compute each division's financial results as if it were a stand-alone entity. Consistent with this approach, borrowed funds and their interest costs are allocated based on the funds actually used by the Company to fund the division's assets and we allocate capital based on regulatory capital rules for the specific assets of each segment. Additionally, transactions between divisions are reflected at arms-length in these financial results, and intercompany profits are eliminated in consolidation. We do not allocate fixed corporate and business unit overhead costs to our profit center divisions, because the methodologies to do so are arbitrary and would distort each division's marginal contribution to our profits. However, the cost of these overhead activities is included in the following tables to reconcile to our consolidated results and is tracked closely, so the responsible managers can be held accountable for the level of these costs and their efficient use.
The following table and discussions explain the recent results of our two major operating segments, mortgage banking and thrift. These activities, combined with the eliminations and other category, which includes supporting deposit and treasury costs as well as eliminating entries, form our total operating results. Our unallocated corporate overhead costs and discontinued business activities are also presented and discussed. We have also included supplemental tables showing detailed division level financial results for each of our major operating segments.
8
The following summarizes our financial results by segment for the periods indicated (dollars in millions):
|
Mortgage Banking Segment |
Thrift Segment |
Eliminations & Other(1) |
Total Operating Results |
Corporate Overhead |
Total On-Going Businesses |
Discontinued Business Activities and Restructuring Charges |
Total Company |
||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Three Months Ended March 31, 2008 | ||||||||||||||||||||||||||||
Operating Results | ||||||||||||||||||||||||||||
Net interest income (expense) | $ | (10.1 | ) | $ | 91.8 | $ | 23.1 | $ | 104.8 | $ | (1.2 | ) | $ | 103.6 | $ | 7.3 | $ | 110.9 | ||||||||||
Provision for loan losses | — | (96.1 | ) | — | (96.1 | ) | — | (96.1 | ) | (35.4 | ) | (131.5 | ) | |||||||||||||||
Gain (loss) on sale of loans | 134.9 | 0.9 | (22.5 | ) | 113.2 | — | 113.2 | (21.2 | ) | 92.1 | ||||||||||||||||||
Service fee income (expense) | 77.2 | — | 115.5 | 192.7 | — | 192.7 | 0.2 | 192.9 | ||||||||||||||||||||
Gain (loss) on securities | (1.8 | ) | (53.5 | ) | (102.4 | ) | (157.7 | ) | — | (157.7 | ) | (2.6 | ) | (160.3 | ) | |||||||||||||
Other income (expense) | 31.1 | 4.3 | (0.3 | ) | 35.1 | 1.4 | 36.5 | 2.1 | 38.6 | |||||||||||||||||||
Net revenues (expense) | 231.3 | (52.6 | ) | 13.4 | 192.1 | 0.2 | 192.3 | (49.6 | ) | 142.7 | ||||||||||||||||||
Operating expenses | 238.2 | 44.6 | 16.0 | 298.8 | 41.1 | 339.9 | 22.6 | 362.5 | ||||||||||||||||||||
Restructuring charges | — | — | — | — | — | — | 72.4 | 72.4 | ||||||||||||||||||||
Pre-tax loss | (6.9 | ) | (97.2 | ) | (2.6 | ) | (106.7 | ) | (40.9 | ) | (147.6 | ) | (144.6 | ) | (292.2 | ) | ||||||||||||
Minority interests | 3.9 | 4.5 | 1.1 | 9.5 | 0.2 | 9.7 | 0.9 | 10.6 | ||||||||||||||||||||
Net loss | $ | (8.2 | ) | $ | (63.9 | ) | $ | (2.6 | ) | $ | (74.7 | ) | $ | (25.1 | ) | $ | (99.8 | ) | $ | (84.4 | ) | $ | (184.2 | ) | ||||
Performance Data | ||||||||||||||||||||||||||||
Average interest-earning assets | $ | 4,372.2 | $ | 21,308.7 | $ | (32.4 | ) | $ | 25,648.5 | $ | 644.1 | $ | 26,292.6 | $ | 3,197.0 | $ | 29,489.6 | |||||||||||
Allocated capital | 574.6 | 668.4 | 1.5 | 1,244.5 | (91.1 | ) | 1,153.4 | 141.5 | 1,294.9 | |||||||||||||||||||
Loans produced | 9,368.5 | 343.7 | N/A | 9,712.2 | N/A | 9,712.2 | 0.2 | 9,712.4 | ||||||||||||||||||||
Loans sold | 10,142.2 | 503.6 | (905.6 | ) | 9,740.2 | N/A | 9,740.2 | 179.7 | 9,919.9 | |||||||||||||||||||
MBR margin | 1.43 | % | 0.17 | % | N/A | N/A | N/A | 1.27 | % | (11.78 | )% | 1.03 | % | |||||||||||||||
ROE | (6 | )% | (38 | )% | N/A | (24 | )% | N/A | (35 | )% | (240 | )% | (57 | )% | ||||||||||||||
Net interest margin | N/A | 1.73 | % | N/A | 1.64 | % | N/A | 1.59 | % | 0.91 | % | 1.51 | % | |||||||||||||||
Net interest margin, thrift | N/A | 1.73 | % | N/A | N/A | N/A | 2.09 | % | N/A | N/A | ||||||||||||||||||
Average FTE | 6,405 | 224 | 351 | 6,980 | 1,046 | 8,026 | 143 | 8,169 | ||||||||||||||||||||
Three Months Ended March 31, 2007 |
||||||||||||||||||||||||||||
Operating Results | ||||||||||||||||||||||||||||
Net interest income (expense) | $ | 24.7 | $ | 47.2 | $ | 24.3 | $ | 96.2 | $ | (3.8 | ) | $ | 92.4 | $ | 42.7 | $ | 135.1 | |||||||||||
Provision for loan losses | — | (10.0 | ) | — | (10.0 | ) | — | (10.0 | ) | (0.7 | ) | (10.7 | ) | |||||||||||||||
Gain (loss) on sale of loans | 137.6 | 3.9 | (22.2 | ) | 119.3 | — | 119.3 | (1.8 | ) | 117.5 | ||||||||||||||||||
Service fee income (expense) | 51.1 | — | (2.4 | ) | 48.7 | — | 48.7 | 0.5 | 49.2 | |||||||||||||||||||
Gain (loss) on securities | (0.3 | ) | (1.6 | ) | 0.7 | (1.2 | ) | — | (1.2 | ) | (4.1 | ) | (5.3 | ) | ||||||||||||||
Other income | 5.8 | 7.1 | 1.0 | 13.9 | 0.6 | 14.5 | 1.8 | 16.3 | ||||||||||||||||||||
Net revenues (expense) | 218.9 | 46.6 | 1.4 | 266.9 | (3.2 | ) | 263.7 | 38.4 | 302.1 | |||||||||||||||||||
Operating expenses | 187.6 | 19.0 | 14.2 | 220.8 | 44.5 | 265.3 | 19.4 | 284.7 | ||||||||||||||||||||
Deferral of expenses under SFAS 91 | (64.6 | ) | (1.9 | ) | — | (66.5 | ) | — | (66.5 | ) | (2.0 | ) | (68.5 | ) | ||||||||||||||
Pre-tax earnings (loss) | 95.9 | 29.5 | (12.8 | ) | 112.6 | (47.7 | ) | 64.9 | 21.0 | 85.9 | ||||||||||||||||||
Net earnings (loss) | $ | 58.2 | $ | 17.9 | $ | (7.5 | ) | $ | 68.6 | $ | (29.0 | ) | $ | 39.6 | $ | 12.8 | $ | 52.4 | ||||||||||
Performance Data | ||||||||||||||||||||||||||||
Average interest-earning assets | $ | 7,938.9 | $ | 14,277.3 | $ | (90.7 | ) | $ | 22,125.5 | $ | 399.7 | $ | 22,525.2 | $ | 8,504.4 | $ | 31,029.6 | |||||||||||
Allocated capital | 779.2 | 619.1 | 2.0 | 1,400.3 | 160.3 | 1,560.6 | 472.3 | 2,032.9 | ||||||||||||||||||||
Loans produced | 16,365.8 | 812.5 | N/A | 17,178.3 | N/A | 17,178.3 | 8,752.0 | 25,930.3 | ||||||||||||||||||||
Loans sold | 16,139.3 | 1,427.3 | (2,025.0 | ) | 15,541.6 | N/A | 15,541.6 | 8,995.3 | 24,536.9 | |||||||||||||||||||
MBR margin | 1.04 | % | 0.27 | % | N/A | N/A | N/A | 0.96 | % | 0.20 | % | 0.68 | % | |||||||||||||||
ROE | 30 | % | 12 | % | N/A | 20 | % | N/A | 10 | % | 11 | % | 10 | % | ||||||||||||||
Net interest margin | N/A | 1.34 | % | N/A | 1.76 | % | N/A | 1.66 | % | 2.04 | % | 1.77 | % | |||||||||||||||
Net interest margin, thrift | N/A | 1.34 | % | N/A | N/A | N/A | 1.88 | % | N/A | N/A | ||||||||||||||||||
Average FTE | 6,259 | 440 | 319 | 7,018 | 1,353 | 8,371 | 384 | 8,755 | ||||||||||||||||||||
Quarter to Quarter Comparison | ||||||||||||||||||||||||||||
% change in net earnings | (114 | )% | (456 | )% | 65 | % | (209 | )% | 13 | % | (352 | )% | (193 | )% | (452 | )% | ||||||||||||
% change in capital | (26 | )% | 8 | % | (27 | )% | (11 | )% | (157 | )% | (26 | )% | (70 | )% | (36 | )% |
9
Our mortgage banking segment consists of the mortgage production division, the mortgage servicing division and the commercial banking division. The mortgage banking segment reported a net loss of $8 million for the quarter ended March 31, 2008 compared with net earnings of $58 million for the quarter ended March 31, 2007. These lower results were caused by a large decline in earnings from our mortgage production division, which reported a $17 million after-tax loss this quarter, partially offset by strong returns in the mortgage servicing division.
The loss this quarter in our production division reflects the continued severe disruption in the secondary market for loans and securities not sold to the GSEs and our resulting efforts to rapidly change our production business model from a primary focus on non-GSE mortgage banking to a model that produces loans that are more than 85% eligible for sale to the GSEs. Although our production segment was not profitable for the quarter, we have reduced the loss 66% from the fourth quarter 2007 loss of $51 million as we right-size our costs and adjust our sales efforts towards the GSE product. As these efforts continue, we expect our production segment to be close to break-even in the second quarter of 2008 and will be profitable in the second half of 2008.
Also hindering profitability in the production segment is the inclusion of two start-up businesses, the retail lending group and commercial mortgage banking division, which are currently unprofitable. These two businesses reported a combined after-tax loss of $14 million in the first quarter of 2008. We expect these businesses to contribute to mortgage banking profits in the subsequent quarters in 2008.
The significant disruption in credit and housing markets that occurred during 2007 and continued this quarter had a materially negative impact on our production results. These disruptions have resulted in higher non-GSE mortgage rates, significantly more restrictive underwriting guidelines and declining home prices, all of which worked to slow prepayments in our servicing portfolio. The loans in our servicing portfolio prepaid at an annual rate of 10% in the first quarter of 2008 compared with 18% in the first quarter of 2007. The expectation of slower non-GSE prepayments offset the impact of lower market interest rates and resulted in positive servicing results.
Net income from our mortgage servicing division decreased from $25 million in the first quarter of 2007 to $20 million in the first quarter of 2008 and resulted in a 23% return on the approximately $349 million of capital we have invested in this division.
10
The following provides details on total mortgage banking segment for the periods indicated (dollars in millions):
|
Mortgage Production Division |
Mortgage Servicing Division |
Consumer Mortgage Banking O/H(1) |
Commercial Mortgage Banking Division |
Total Mortgage Banking Segment |
|||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Three Months Ended March 31, 2008 | ||||||||||||||||||
Operating Results | ||||||||||||||||||
Net interest income (expense) | $ | 10.4 | $ | (22.3 | ) | $ | (0.2 | ) | $ | 2.0 | $ | (10.1 | ) | |||||
Gain (loss) on sale of loans | 119.4 | 17.2 | — | (1.7 | ) | 134.9 | ||||||||||||
Service fee income (expense) | 10.0 | 67.2 | — | — | 77.2 | |||||||||||||
Gain (loss) on securities | — | (1.8 | ) | — | — | (1.8 | ) | |||||||||||
Other income | 25.9 | 4.8 | 0.3 | 0.1 | 31.1 | |||||||||||||
Net revenues | 165.7 | 65.1 | 0.1 | 0.4 | 231.3 | |||||||||||||
Operating expenses | 191.8 | 29.2 | 15.0 | 2.2 | 238.2 | |||||||||||||
Pre-tax earnings (loss) | (26.1 | ) | 35.9 | (14.9 | ) | (1.8 | ) | (6.9 | ) | |||||||||
Minority interests | 1.3 | 2.4 | 0.1 | 0.1 | 3.9 | |||||||||||||
Net earnings (loss) | $ | (17.3 | ) | $ | 19.6 | $ | (9.2 | ) | $ | (1.3 | ) | $ | (8.2 | ) | ||||
Performance Data | ||||||||||||||||||
Average interest-earning assets | $ | 3,024.0 | $ | 1,015.7 | $ | 2.5 | $ | 330.0 | $ | 4,372.2 | ||||||||
Allocated capital | 195.9 | 348.8 | 8.4 | 21.5 | 574.6 | |||||||||||||
Loans produced | 8,019.3 | 1,228.1 | N/A | 121.2 | 9,368.5 | |||||||||||||
Loans sold | 8,692.5 | 1,324.1 | N/A | 125.5 | 10,142.2 | |||||||||||||
MBR margin | 1.49 | % | 1.30 | % | N/A | N/A | 1.43 | % | ||||||||||
ROE | (36 | )% | 23 | % | N/A | (24 | )% | (6 | )% | |||||||||
Net interest margin | 1.38 | % | N/A | N/A | 2.45 | % | N/A | |||||||||||
Average FTE | 4,452 | 454 | 1,449 | 50 | 6,405 | |||||||||||||
Three Months Ended March 31, 2007 |
||||||||||||||||||
Operating Results | ||||||||||||||||||
Net interest income (expense) | $ | 29.7 | $ | (5.0 | ) | $ | — | $ | — | $ | 24.7 | |||||||
Gain (loss) on sale of loans | 120.3 | 17.3 | — | — | 137.6 | |||||||||||||
Service fee income | 7.2 | 43.9 | — | — | 51.1 | |||||||||||||
Loss on securities | — | (0.3 | ) | — | — | (0.3 | ) | |||||||||||
Other income | 0.8 | 3.8 | 1.2 | — | 5.8 | |||||||||||||
Net revenues | 158.0 | 59.7 | 1.2 | — | 218.9 | |||||||||||||
Operating expenses | 148.1 | 21.9 | 16.5 | 1.1 | 187.6 | |||||||||||||
Deferral of expenses under SFAS 91 | (61.5 | ) | (3.1 | ) | — | — | (64.6 | ) | ||||||||||
Pre-tax earnings (loss) | 71.4 | 40.9 | (15.3 | ) | (1.1 | ) | 95.9 | |||||||||||
Net earnings (loss) | $ | 43.2 | $ | 24.9 | $ | (9.3 | ) | $ | (0.6 | ) | $ | 58.2 | ||||||
Performance Data | ||||||||||||||||||
Average interest-earning assets | $ | 7,027.7 | $ | 908.6 | $ | 2.6 | $ | — | $ | 7,938.9 | ||||||||
Allocated capital | 440.5 | 332.1 | 6.6 | — | 779.2 | |||||||||||||
Loans produced | 15,247.4 | 1,118.4 | N/A | 1.0 | 16,365.8 | |||||||||||||
Loans sold | 14,961.7 | 1,177.6 | N/A | — | 16,139.3 | |||||||||||||
MBR margin | 1.00 | % | 1.47 | % | N/A | N/A | 1.04 | % | ||||||||||
ROE | 40 | % | 30 | % | N/A | N/A | 30 | % | ||||||||||
Net interest margin | 1.71 | % | N/A | N/A | N/A | N/A | ||||||||||||
Average FTE | 4,781 | 278 | 1,186 | 14 | 6,259 | |||||||||||||
Quarter to Quarter Comparison | ||||||||||||||||||
% change in net earnings (loss) | (140 | )% | (21 | )% | 2 | % | (88 | )% | (114 | )% | ||||||||
% change in equity | (56 | )% | 5 | % | 27 | % | N/M | (26 | )% |
11
The mortgage production division originates loans through three divisions: retail channel, mortgage professionals channel and Financial Freedom. This division sources loans through relationships with mortgage brokers, financial institutions, Realtors®, and homebuilders.
The mortgage professionals channel is the largest channel in our mortgage production division, funding loans originated through mortgage brokers and emerging mortgage bankers nationwide. The retail channel provides mortgage financing directly to home purchase oriented consumers by targeting Realtors®, homebuilders and financial professionals via storefront mortgage loan offices. As of March 31, 2008, we have 152 retail mortgage offices/branches throughout the U.S. Financial Freedom provides reverse mortgage products directly to seniors (age 62 and older) through the mortgage professionals channel. Through this division, we remain the leader in the fast growing reverse mortgage market. Financial Freedom also retains mortgage servicing rights ("MSRs") and receives fees and ancillary revenues for servicing loans sold into the secondary market.
The following provides details on the results for the mortgage production division for the periods indicated (dollars in millions):
|
Consumer Direct Division(1) |
Retail Channel |
Mortgage Professionals Channel |
Financial Freedom Division |
Total Mortgage Production Division |
|||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Three Months Ended March 31, 2008 | ||||||||||||||||||
Operating Results | ||||||||||||||||||
Net interest income | $ | — | $ | 1.3 | $ | 4.4 | $ | 4.7 | $ | 10.4 | ||||||||
Gain on sale of loans | — | 22.8 | 78.4 | 18.2 | 119.4 | |||||||||||||
Service fee income | — | — | — | 10.0 | 10.0 | |||||||||||||
Other income | — | 11.1 | 14.8 | — | 25.9 | |||||||||||||
Net revenues | — | 35.2 | 97.6 | 32.9 | 165.7 | |||||||||||||
Operating expenses | — | 55.3 | 107.8 | 28.7 | 191.8 | |||||||||||||
Pre-tax earnings (loss) | — | (20.1 | ) | (10.2 | ) | 4.2 | (26.1 | ) | ||||||||||
Minority interests | — | 0.2 | 0.4 | 0.7 | 1.3 | |||||||||||||
Net earnings (loss) | $ | — | $ | (12.4 | ) | $ | (6.7 | ) | $ | 1.8 | $ | (17.3 | ) | |||||
Performance Data | ||||||||||||||||||
Average interest-earning assets | $ | — | $ | 462.7 | $ | 1,842.8 | $ | 718.5 | $ | 3,024.0 | ||||||||
Allocated capital | — | 24.8 | 64.2 | 106.9 | 195.9 | |||||||||||||
Loans produced | — | 1,232.7 | 5,728.9 | 1,057.7 | 8,019.3 | |||||||||||||
Loans sold | — | 1,015.0 | 6,014.6 | 1,662.9 | 8,692.5 | |||||||||||||
MBR margin | — | 2.37 | % | 1.38 | % | 1.38 | % | 1.49 | % | |||||||||
ROE | — | (203 | )% | (42 | )% | 7 | % | (36 | )% | |||||||||
Net interest margin | — | 1.09 | % | 0.97 | % | 2.62 | % | 1.38 | % | |||||||||
Average FTE | — | 1,952 | 1,419 | 1,081 | 4,452 |
12
Three Months Ended March 31, 2007 |
||||||||||||||||||
Operating Results | ||||||||||||||||||
Net interest income | $ | 0.4 | $ | 0.1 | $ | 23.5 | $ | 5.7 | $ | 29.7 | ||||||||
Gain on sale of loans | 3.9 | 0.5 | 52.8 | 63.1 | 120.3 | |||||||||||||
Service fee income | — | — | — | 7.2 | 7.2 | |||||||||||||
Other income | 0.2 | 0.4 | — | 0.2 | 0.8 | |||||||||||||
Net revenues | 4.5 | 1.0 | 76.3 | 76.2 | 158.0 | |||||||||||||
Operating expenses | 7.8 | 2.0 | 101.0 | 37.3 | 148.1 | |||||||||||||
Deferral of expenses under SFAS 91 | (3.5 | ) | (0.1 | ) | (50.4 | ) | (7.5 | ) | (61.5 | ) | ||||||||
Pre-tax earnings (loss) | 0.2 | (0.9 | ) | 25.7 | 46.4 | 71.4 | ||||||||||||
Net earnings (loss) | $ | 0.1 | $ | (0.5 | ) | $ | 15.6 | $ | 28.0 | $ | 43.2 | |||||||
Performance Data | ||||||||||||||||||
Average interest-earning assets | $ | 133.8 | $ | 18.0 | $ | 5,892.4 | $ | 983.5 | $ | 7,027.7 | ||||||||
Allocated capital | 6.6 | 0.8 | 298.7 | 134.4 | 440.5 | |||||||||||||
Loans produced | 319.5 | 49.4 | 13,656.1 | 1,221.4 | 15,246.4 | |||||||||||||
Loans sold | 329.1 | 44.7 | 13,061.8 | 1,526.1 | 14,961.7 | |||||||||||||
MBR margin | 1.3 | % | N/A | 0.58 | % | 4.51 | % | 1.00 | % | |||||||||
ROE | 7 | % | N/A | 21 | % | 85 | % | 40 | % | |||||||||
Net interest margin | 1.18 | % | N/A | 1.62 | % | 2.36 | % | 1.71 | % | |||||||||
Average FTE | 281 | 78 | 2,974 | 1,448 | 4,781 | |||||||||||||
Quarter to Quarter Comparison |
||||||||||||||||||
% change in net earnings | N/M | N/M | (143 | )% | (94 | )% | (140 | )% | ||||||||||
% change in capital | N/M | N/M | (78 | )% | (20 | )% | (56 | )% |
The following summarizes the key production drivers for the mortgage professionals channel for the periods indicated:
|
Three Months Ended |
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
March 31 |
|
|
|
|||||||
|
% Change |
December 31, 2007 |
% Change |
||||||||
|
2008 |
2007 |
|||||||||
Key Production Drivers: | |||||||||||
Active customers(1) | 5,754 | 8,290 | (31 | )% | 8,294 | (31 | )% | ||||
Sales personnel | 927 | 1,182 | (22 | )% | 1,140 | (19 | )% | ||||
Number of regional offices | 9 | 16 | (44 | )% | 16 | (44 | )% |
Loan production and sales are the drivers of our mortgage banking segment. While the mortgage production division contributes 83% to our total loan originations, the following discussion refers to our total production, through both the mortgage banking and thrift segments.
We generated SFR mortgage loan production of $9.6 billion for the quarter ended March 31, 2008, down 62.5% and 21.0%, respectively, compared to $25.9 billion and $12.3 billion for the first quarter of 2007 and fourth quarter of 2007, respectively. The current quarter decline in loan production from the first quarter of 2007 was attributable to the discontinuation of the conduit channel, the elimination of the majority of our non-agency product, and the decline in the overall mortgage market. We exited the conduit channel in the last quarter of 2007 as a response to the disruption in the secondary market. Additionally, in
13
all of our origination channels, we significantly restricted our guidelines on non-agency loans. As a result, our non-agency production decreased to 12% of total production during the first quarter of 2008.
On April 10, 2008, the MBA issued an estimate of the industry volume for the quarter ended March 31, 2008 of $565.0 billion, which represents a 9.7% decrease from $626.0 billion at March 31, 2007 but an increase of 22.6% from $461.0 billion at December 31, 2007. Based on this estimate, our market share is 1.7% for the quarter ended March 31, 2008, down from 4.1% and 2.6% in the quarters ended March 31, 2007 and December 31, 2007, respectively. At March 31, 2008, our total pipeline of SFR mortgage loans in process was $5.1 billion, down 68.3% from $16.1 billion at March 31, 2007, and down 32.0% from $7.5 billion at December 31, 2007.
The following summarizes our loan production by division and channel for the periods indicated (dollars in millions):
|
Three Months Ended |
||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
March 31 |
|
|
|
|||||||||||
|
% Change |
December 31, 2007 |
% Change |
||||||||||||
|
2008 |
2007 |
|||||||||||||
Production by Division: | |||||||||||||||
SFR mortgage loan production: | |||||||||||||||
Mortgage professionals channel | $ | 5,729 | $ | 13,656 | (58 | )% | $ | 8,186 | (30 | )% | |||||
Retail channel | 1,233 | 49 | N/M | 1,056 | 17 | % | |||||||||
Consumer direct division | — | 320 | (100 | )% | 191 | (100 | )% | ||||||||
Financial Freedom division | 1,058 | 1,221 | (13 | )% | 1,164 | (9 | )% | ||||||||
Servicing retention division | 1,228 | 1,118 | 10 | % | 933 | 32 | % | ||||||||
Consumer construction division(1) | 343 | 812 | (58 | )% | 499 | (31 | )% | ||||||||
Total on-going businesses | 9,591 | 17,176 | (44 | )% | 12,029 | (20 | )% | ||||||||
Conduit channel | — | 8,368 | (100 | )% | 57 | (100 | )% | ||||||||
Home equity division(1) | — | 25 | (100 | )% | 3 | (100 | )% | ||||||||
Total discontinued business activities | — | 8,393 | (100 | )% | 60 | (100 | )% | ||||||||
Total SFR mortgage loan production | 9,591 | 25,569 | (62 | )% | 12,089 | (21 | )% | ||||||||
Commercial loan production: | |||||||||||||||
Commercial mortgage banking division—on-going businesses | 121 | 1 | N/M | 190 | (36 | )% | |||||||||
Homebuilder division(1)—discontinued business activities | — | 360 | (100 | )% | 22 | (100 | )% | ||||||||
Total loan production | $ | 9,712 | $ | 25,930 | (63 | )% | $ | 12,301 | (21 | )% | |||||
Total pipeline of SFR mortgage loans in process at period end | $ | 5,107 | $ | 16,112 | (68 | )% | $ | 7,506 | (32 | )% | |||||
14
The following summarizes our loan production by product type for the periods indicated (dollars in millions):
|
Three Months Ended |
|||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
March 31 |
|
|
|
||||||||||||
|
% Change |
December 31, 2007 |
% Change |
|||||||||||||
|
2008 |
2007 |
||||||||||||||
Production by Product Type: | ||||||||||||||||
Standard first mortgage products: | ||||||||||||||||
Agency eligible(1) | $ | 7,512 | $ | 11,830 | (37 | )% | $ | 8,356 | (10 | )% | ||||||
Prime jumbo(1) | 670 | 6,816 | (90 | )% | 1,674 | (60 | )% | |||||||||
Other prime(1) | — | 2,073 | (100 | )% | — | N/A | ||||||||||
Subprime(1) | — | 1,084 | (100 | )% | 186 | (100 | )% | |||||||||
Total standard first mortgage products (S&P evaluated) | 8,182 | 21,803 | (62 | )% | 10,216 | (20 | )% | |||||||||
Specialty consumer home mortgage products: | ||||||||||||||||
HELOCs(2)/Seconds | 42 | 1,703 | (98 | )% | 280 | (85 | )% | |||||||||
Reverse mortgages | 1,058 | 1,221 | (13 | )% | 1,164 | (9 | )% | |||||||||
Consumer construction(2) | 112 | 842 | (87 | )% | 385 | (71 | )% | |||||||||
Government—FHA/VA(3) | 197 | — | N/A | 44 | 348 | % | ||||||||||
Subtotal SFR mortgage production | 9,591 | 25,569 | (62 | )% | 12,089 | (21 | )% | |||||||||
Commercial loan products: | ||||||||||||||||
Commercial real estate | 121 | 1 | N/M | 190 | (36 | )% | ||||||||||
Builder construction commitments(2) | — | 360 | (100 | )% | 22 | (100 | )% | |||||||||
Total production | $ | 9,712 | $ | 25,930 | (63 | )% | $ | 12,301 | (21 | )% | ||||||
Total S&P lifetime loss estimate(4) | 0.23 | % | 1.86 | % | (88 | )% | 0.43 | % | (47 | )% |
15
The following shows the various channels through which loans were distributed for the Company during the periods indicated (dollars in millions):
|
Three Months Ended |
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
March 31 |
|
|||||||||
|
December 31, 2007 |
||||||||||
|
2008 |
2007 |
|||||||||
Distribution of Loans by Channel: | |||||||||||
Sales to GSE's | 84 | % | 30 | % | 75 | % | |||||
Private-label securitizations | 1 | % | 30 | % | 25 | % | |||||
Whole loan sales, servicing retained | 4 | % | 39 | % | — | ||||||
Whole loan sales, servicing released | 11 | % | 1 | % | — | ||||||
Total loan sales percentage | 100 | % | 100 | % | 100 | % | |||||
Total loan sales | $ | 9,920 | $ | 24,537 | $ | 13,425 | |||||
Due to the disruptions in the secondary mortgage market, we have tightened our guidelines and focused primarily on GSE eligible mortgage products. As a result, sales to GSEs increased significantly to 84% of total loan distribution for the first quarter of 2008, up from 30% and 75% for the first quarter of 2007 and fourth quarter of 2007, respectively. We expect that a very high percentage of our loan sales going forward will be to the GSEs until the private MBS market recovers.
In conjunction with the sale of mortgage loans, we generally retain certain assets. The primary assets retained include MSRs and, to a lesser degree, AAA-rated and agency interest-only securities, AAA-rated principal-only securities, prepayment penalty securities, late fee securities, investment and non-investment grade securities, and residual securities. The allocated cost of the retained assets at the time of sale is recorded as an asset with an offsetting increase to the gain on sale of loans (or a reduction in the cost basis of the loans sold). During the quarter ended March 31, 2008, the calculation of gain (loss) on sales of loans included the retention of $135 million of MSRs and $1 million of residual securities. For more information on the valuation assumptions related to our retained assets, see "Table 15. Valuation of MSRs, Interest-Only, Prepayment Penalty, and Residual Securities" of "Appendix A: Additional Quantitative Disclosures."
The profitability of our loans is measured by the MBR margin, which is calculated using mortgage banking revenue divided by the amount of total loans sold. MBR includes total consolidated gain (loss) on sale of loans and the net interest income earned on mortgage loans held for sale by mortgage banking production division. Most of the gain (loss) on sale of loans resulted from the loan sale activities in our mortgage banking segment. The gain (loss) on sale recognized in the thrift segment is included in the MBR margin calculation.
16
The following summarizes the amount of loans sold and the MBR margin during the periods indicated (dollars in millions):
|
Three Months Ended |
|||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
March 31 |
|
|
|
||||||||||
|
% Change |
December 31, 2007 |
% Change |
|||||||||||
|
2008 |
2007 |
||||||||||||
Total loans sold | $ | 9,920 | $ | 24,537 | (60 | )% | $ | 13,425 | (26 | )% | ||||
MBR margin after production hedging | 1.30 | % | 1.11 | % | 17 | % | 0.77 | % | 69 | % | ||||
MBR margin after credit costs | 1.03 | % | 0.88 | % | 17 | % | (1.88 | )% | (155 | )% | ||||
Net MBR margin | 1.03 | % | 0.68 | % | 51 | % | (2.18 | )% | (147 | )% |
For more details on our MBR margin, see "Table 6. MBR Margin" of "Appendix A: Additional Quantitative Disclosures."
Servicing is a key component of our business model, as it is a natural complement to our mortgage production operations and its financial performance tends to run countercyclical to the mortgage production business. Our mortgage servicing platform remains a strong and stable source of profitability in the midst of the current mortgage market turmoil.
Through MSRs retained from our mortgage banking activities, we collect fees and ancillary revenues for servicing loans sold into the secondary market. As interest rates rise and/or mortgage spreads widen, the expected life of the underlying loans is generally extended, which extends the life of the income stream flowing from those loans. This in turn increases the capitalized value of the associated MSRs. Conversely, as interest rates decline and/or mortgage spreads tighten, the value of the MSRs may also decline. To mitigate the potential volatility in the MSRs, we hedge this asset to earn a stable return throughout the interest rate cycle. For more information on servicing hedges, see the "Consolidated Risk Management Discussion" section.
Our MSRs increased to $2,560 million at March 31, 2008 from $2,495 million at December 31, 2007. The lower mortgage interest rates were more than offset by gains in value in our hedging instruments and from a continued decline in actual prepayment speeds in the year. Actual prepayment speeds have declined due to the impact of tighter guidelines on available mortgage loans in the market and declining home prices limiting the refinance capability of consumers.
Our servicing portfolio provides opportunities to cross sell other products, such as checking accounts, certificates of deposit, and other deposit services. In a declining interest rate environment, our servicing portfolio provides an existing base of customers who may be in the market to refinance. Capturing or "retaining" these customers helps mitigate the decline in the value of our mortgage servicing asset caused by prepayment of the original loan.
The fair value of our MSRs is determined using discounted cash flow techniques benchmarked against a third-party opinion of value. Estimates of fair value involve several assumptions, including assumptions about future prepayment rates, market expectations of future interest rates, cost to service the loans (including default management costs), ancillary incomes, and discount rates. Prepayment speeds are projected using a prepayment model developed by a third-party vendor and calibrated for the Company's collateral. The model considers key factors, such as refinance incentive, housing turnover, seasonality, and aging of the pool of loans. Prepayment speeds incorporate expectations of future rates implied by the market forward LIBOR/swap curve, as well as collateral specific current coupon information. For further detail on the valuation assumptions, see "Table 15. Valuation of MSRs, Interest-Only, Prepayment Penalty, and Residual Securities" of "Appendix A: Additional Quantitative Disclosures."
17
The following provides additional details on the results for the mortgage servicing division for the periods indicated (dollars in millions):
|
Mortgage Servicing Rights Channel |
Servicing Retention Channel |
Total Mortgage Servicing Division |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
Three Months Ended March 31, 2008 | ||||||||||||
Operating Results | ||||||||||||
Net interest income (expense) | $ | (24.7 | ) | $ | 2.4 | $ | (22.3 | ) | ||||
Gain on sale of loans | — | 17.2 | 17.2 | |||||||||
Service fee income | 67.2 | — | 67.2 | |||||||||
Loss on securities | (1.8 | ) | — | (1.8 | ) | |||||||
Other income | 2.1 | 2.7 | 4.8 | |||||||||
Net revenues | 42.8 | 22.3 | 65.1 | |||||||||
Operating expenses | 14.5 | 14.7 | 29.2 | |||||||||
Pre-tax earnings | 28.3 | 7.6 | 35.9 | |||||||||
Minority interests | 2.2 | 0.2 | 2.4 | |||||||||
Net earnings | $ | 15.2 | $ | 4.4 | $ | 19.6 | ||||||
Performance Data | ||||||||||||
Average interest-earning assets | $ | 224.8 | $ | 790.9 | $ | 1,015.7 | ||||||
Allocated capital | 321.5 | 27.3 | 348.8 | |||||||||
Loans produced | — | 1,228.1 | 1,228.1 | |||||||||
Loans sold | — | 1,324.1 | 1,324.1 | |||||||||
MBR Margin | N/A | 1.30 | % | 1.30 | % | |||||||
ROE | 19 | % | 64 | % | 23 | % | ||||||
Net interest margin | N/A | 1.19 | % | N/A | ||||||||
Average FTE | 99 | 355 | 454 | |||||||||
Three Months Ended March 31, 2007 |
||||||||||||
Operating Results | ||||||||||||
Net interest income (expense) | $ | (8.0 | ) | $ | 3.0 | $ | (5.0 | ) | ||||
Gain (loss) on sale of loans | 0.6 | 16.7 | 17.3 | |||||||||
Service fee income | 43.9 | — | 43.9 | |||||||||
Loss on securities | (0.3 | ) | — | (0.3 | ) | |||||||
Other income | 1.8 | 2.0 | 3.8 | |||||||||
Net revenues | 38.0 | 21.7 | 59.7 | |||||||||
Operating expenses | 11.2 | 10.7 | 21.9 | |||||||||
Deferral of expenses under SFAS 91 | — | (3.1 | ) | (3.1 | ) | |||||||
Pre-tax earnings | 26.8 | 14.1 | 40.9 | |||||||||
Net income | $ | 16.2 | $ | 8.7 | $ | 24.9 | ||||||
Performance Data | ||||||||||||
Average interest-earning assets | $ | 214.1 | $ | 694.5 | $ | 908.6 | ||||||
Allocated capital | 300.4 | 31.7 | 332.1 | |||||||||
Loans produced | — | 1,118.4 | 1,118.4 | |||||||||
Loans sold | — | 1,177.6 | 1,177.6 | |||||||||
MBR Margin | N/A | 1.42 | % | 1.47 | % | |||||||
ROE | 22 | % | 111 | % | 30 | % | ||||||
Net interest margin | N/A | N/A | N/A | |||||||||
Average FTE | 91 | 187 | 278 | |||||||||
Quarter to Quarter Comparison | ||||||||||||
% change in net earnings | (6 | )% | (50 | )% | (21 | )% | ||||||
% change in capital | 7 | % | (14 | )% | 5 | % |
18
SFR mortgage loans serviced for others reached $184.5 billion (including reverse mortgages and HELOCs) at March 31, 2008, with a weighted average coupon of 6.60%. In comparison, we serviced $156.1 billion of mortgage loans owned by others at March 31, 2007, with a weighted average coupon of 7.09%, and $181.7 billion at December 31, 2007, with a weighted average coupon of 6.89%.
The following provides the activity in the servicing portfolio for the periods indicated (in millions):
|
Three Months Ended |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
March 31 |
|
||||||||
|
December 31, 2007 |
|||||||||
|
2008 |
2007 |
||||||||
Unpaid principal balance at beginning of period | $ | 181,724 | $ | 139,817 | $ | 173,915 | ||||
Additions | 9,450 | 24,690 | 13,967 | |||||||
Loan payments and prepayments | (6,639 | ) | (8,363 | ) | (6,158 | ) | ||||
Unpaid principal balance at end of period | $ | 184,535 | $ | 156,144 | $ | 181,724 | ||||
The following provides additional information related to the servicing portfolio as of the dates indicated:
|
March 31 |
|
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
|
December 31, 2007 |
|||||||||||
|
2008 |
2007 |
||||||||||
By Product Type: | ||||||||||||
Fixed-rate mortgages | 39 | % | 35 | % | 36 | % | ||||||
Intermediate term fixed-rate loans | 33 | % | 32 | % | 35 | % | ||||||
Pay option adjustable-rate mortgages ("ARMs") | 16 | % | 21 | % | 17 | % | ||||||
Reverse mortgages | 10 | % | 9 | % | 10 | % | ||||||
HELOCs | 1 | % | 2 | % | 1 | % | ||||||
Other | 1 | % | 1 | % | 1 | % | ||||||
Total | 100 | % | 100 | % | 100 | % | ||||||
Additional Information(1): | ||||||||||||
Weighted average FICO(2) | 703 | 703 | 702 | |||||||||
Weighted average original loan-to-value ("LTV") ratio(3) | 72 | % | 72 | % | 73 | % | ||||||
Average original loan size (in millions) | $ | 0.2 | $ | 0.2 | $ | 0.2 | ||||||
Percent of portfolio with prepayment penalty | 29 | % | 41 | % | 33 | % | ||||||
Portfolio delinquency (% of unpaid principal balance)(4) | 8.26 | % | 5.41 | % | 7.31 | % | ||||||
By Geographic Distribution: | ||||||||||||
California | 43 | % | 43 | % | 43 | % | ||||||
Florida | 8 | % | 8 | % | 8 | % | ||||||
New York | 8 | % | 8 | % | 8 | % | ||||||
New Jersey | 4 | % | 4 | % | 4 | % | ||||||
Virginia | 3 | % | 4 | % | 4 | % | ||||||
Others | 34 | % | 33 | % | 33 | % | ||||||
Total | 100 | % | 100 | % | 100 | % | ||||||
19
with low risk of default, but in general, the secondary market will consider FICO scores of 620 or higher to be prime.
Our thrift segment invests in loans originated by our various production units as well as in MBS. We manage our investments in the thrift portfolio based on the extent to which the ROEs exceed the cost of both core and risk-based capital, or they are needed to support the core mortgage banking investments in mortgage servicing rights and residual and non-investment grade securities, if the ROEs are below our cost of capital. These investing activities provide core spread income and we believe, generally, a more stable return on equity. Additionally, the segment engages in consumer construction lending.
Our thrift segment reported a $64 million net loss in the first quarter of 2008, as compared to net earnings of $18 million in the first quarter of 2007, primarily due to an increase in credit related costs. Credit related costs for the thrift segment are reflected in the provision for loan losses as well as the valuation of our investment grade, non-investment grade and residual securities. Credit costs in the thrift segment for the quarter ended March 31, 2008 totaled $223 million pre-tax compared with only $23 million for the quarter ended March 31, 2007. Although all the divisions in the thrift segment incurred higher credit costs in the first quarter of 2008, the majority of the increase was concentrated in the SFR Mortgage Loans HFI division.
20
The following provides details on the results for divisions of our thrift segment for the periods indicated (dollars in millions):
|
Investment Grade Securities Channel |
Non- Investment Grade and Residual Securities Channel |
Total Mortgage- Backed Securities Division |
SFR Mortgage Loans HFI Division |
Consumer Construction Division |
Warehouse Lending Division |
Total Thrift Segment |
|||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Three Months Ended March 31, 2008 | ||||||||||||||||||||||||
Operating Results | ||||||||||||||||||||||||
Net interest income | $ | 24.2 | $ | 12.8 | $ | 37.0 | $ | 45.2 | $ | 9.5 | $ | 0.1 | $ | 91.8 | ||||||||||
Provision for loan losses | — | — | — | (75.0 | ) | (21.1 | ) | — | (96.1 | ) | ||||||||||||||
Gain on sale of loans | — | — | — | (2.3 | ) | 3.2 | — | 0.9 | ||||||||||||||||
Gain (loss) on securities | (25.6 | ) | (27.4 | ) | (53.0 | ) | (0.6 | ) | 0.1 | — | (53.5 | ) | ||||||||||||
Other income (expense) | — | — | — | 1.4 | 2.8 | 0.1 | 4.3 | |||||||||||||||||
Net revenues (expense) | (1.4 | ) | (14.6 | ) | (16.0 | ) | (31.3 | ) | (5.5 | ) | 0.2 | (52.6 | ) | |||||||||||
Operating expenses | 0.3 | 1.0 | 1.3 | 31.8 | 11.0 | 0.5 | 44.6 | |||||||||||||||||
Pre-tax loss | (1.7 | ) | (15.6 | ) | (17.3 | ) | (63.1 | ) | (16.5 | ) | (0.3 | ) | (97.2 | ) | ||||||||||
Minority interests | 0.6 | 0.9 | 1.5 | 2.5 | 0.5 | — | 4.5 | |||||||||||||||||
Net loss | $ | (1.7 | ) | $ | (10.4 | ) | $ | (12.1 | ) | $ | (41.1 | ) | $ | (10.6 | ) | $ | (0.1 | ) | $ | (63.9 | ) | |||
Performance Data | ||||||||||||||||||||||||
Average interest-earning assets | $ | 6,638.6 | $ | 280.5 | $ | 6,919.1 | $ | 11,829.4 | $ | 2,480.7 | $ | 79.5 | $ | 21,308.7 | ||||||||||
Allocated capital | 90.7 | 129.3 | 220.0 | 365.2 | 78.6 | 4.6 | 668.4 | |||||||||||||||||
Loans produced | — | — | — | — | 343.7 | — | 343.7 | |||||||||||||||||
Loans sold | — | — | — | 380.6 | 123.0 | — | 503.6 | |||||||||||||||||
ROE | (7 | )% | (32 | )% | (22 | )% | (45 | )% | (54 | )% | (13 | )% | (38 | )% | ||||||||||
Net interest margin, thrift. | 1.46 | % | 18.31 | % | 2.15 | % | 1.54 | % | 1.55 | % | 0.87 | % | 1.73 | % | ||||||||||
Efficiency ratio | (23 | )% | (7 | )% | (8 | )% | 73 | % | 70 | % | 161 | % | 102 | % | ||||||||||
Average FTE | 5 | 12 | 17 | 13 | 173 | 21 | 224 | |||||||||||||||||
Three Months Ended March 31, 2007 |
||||||||||||||||||||||||
Operating Results | ||||||||||||||||||||||||
Net interest income | $ | 6.9 | $ | 10.8 | $ | 17.7 | $ | 14.3 | $ | 13.7 | $ | 1.5 | $ | 47.2 | ||||||||||
Provision for loan losses | — | — | — | (8.5 | ) | (1.4 | ) | (0.1 | ) | (10.0 | ) | |||||||||||||
Gain (loss) on sale of loans | — | — | — | (5.0 | ) | 8.9 | — | 3.9 | ||||||||||||||||
Gain (loss) on securities | (0.2 | ) | (1.4 | ) | (1.6 | ) | — | — | — | (1.6 | ) | |||||||||||||
Other income (expense) | 0.6 | — | 0.6 | 0.5 | 5.3 | 0.7 | 7.1 | |||||||||||||||||
Net revenues (expense) | 7.3 | 9.4 | 16.7 | 1.3 | 26.5 | 2.1 | 46.6 | |||||||||||||||||
Operating expenses | 0.3 | 0.4 | 0.7 | 1.6 | 15.9 | 0.8 | 19.0 | |||||||||||||||||
Deferral of expenses under SFAS 91 | — | — | — | — | (1.9 | ) | — | (1.9 | ) | |||||||||||||||
Pre-tax earnings (loss) | 7.0 | 9.0 | 16.0 | (0.3 | ) | 12.5 | 1.3 | 29.5 | ||||||||||||||||
Net earnings (loss) | $ | 4.3 | $ | 5.5 | $ | 9.8 | $ | (0.2 | ) | $ | 7.6 | $ | 0.7 | $ | 17.9 | |||||||||
Performance Data | ||||||||||||||||||||||||
Average interest-earning assets | $ | 4,406.2 | $ | 271.0 | $ | 4,677.2 | $ | 6,724.5 | $ | 2,646.5 | $ | 229.1 | $ | 14,277.3 | ||||||||||
Allocated capital | 82.5 | 137.0 | 219.5 | 253.6 | 127.7 | 18.3 | 619.1 | |||||||||||||||||
Loans produced | — | — | — | — | 812.5 | — | 812.5 | |||||||||||||||||
Loans sold | — | — | — | 737.5 | 689.8 | — | 1,427.3 | |||||||||||||||||
ROE | 21 | % | 16 | % | 18 | % | — | 24 | % | 16 | % | 12 | % | |||||||||||
Net interest margin, thrift. | 0.64 | % | 16.04 | % | 1.53 | % | 0.86 | % | 2.11 | % | 2.59 | % | 1.34 | % | ||||||||||
Efficiency ratio | 4 | % | 4 | % | 4 | % | 16 | % | 50 | % | 40 | % | 30 | % | ||||||||||
Average FTE | 4 | 5 | 9 | 11 | 391 | 29 | 440 | |||||||||||||||||
Quarter to Quarter Comparison |
||||||||||||||||||||||||
% change in net earnings | (139 | )% | (290 | )% | (224 | )% | N/M | (238 | )% | (120 | )% | (456 | )% | |||||||||||
% change in capital | 10 | % | (6 | )% | — | 44 | % | (39 | )% | (75 | )% | 8 | % |
21
The following tables and discussion present supplemental information to help understand the composition and credit quality of the assets held in our thrift portfolios. This section refers to company-wide assets, a small portion of which may be held in our mortgage banking segment.
MORTGAGE-BACKED SECURITIES DIVISION
The following provides the details of the MBS portfolio as of the dates indicated (in millions):
|
March 31, 2008 |
March 31, 2007 |
December 31, 2007 |
||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Trading |
AFS |
Total |
Trading |
AFS |
Total |
Trading |
AFS |
Total |
||||||||||||||||||
Mortgage banking segment: | |||||||||||||||||||||||||||
AAA-rated and agency interest-only securities | $ | 49 | $ | — | $ | 49 | $ | 69 | $ | — | $ | 69 | 60 | $ | — | $ | 60 | ||||||||||
AAA-rated principal-only securities | 89 | — | 89 | 56 | — | 56 | 88 | — | 88 | ||||||||||||||||||
Prepayment penalty and late fee securities | 74 | — | 74 | 86 | — | 86 | 80 | — | 80 | ||||||||||||||||||
Total mortgage banking | 212 | — | 212 | 211 | — | 211 | 228 | — | 228 | ||||||||||||||||||
Thrift segment: | |||||||||||||||||||||||||||
AAA-rated non-agency securities | 384 | 4,938 | 5,322 | 24 | 4,237 | 4,261 | 418 | 5,478 | 5,896 | ||||||||||||||||||
AAA-rated agency securities | — | 41 | 41 | — | 58 | 58 | — | 45 | 45 | ||||||||||||||||||
AAA-rated and agency interest-only securities | — | — | — | 6 | — | 6 | — | — | — | ||||||||||||||||||
Prepayment penalty and other securities | 1 | — | 1 | 7 | — | 7 | 2 | — | 2 | ||||||||||||||||||
Other investment grade securities | 289 | 434 | 723 | 67 | 262 | 329 | 368 | 517 | 885 | ||||||||||||||||||
Other non-investment grade securities | 103 | 89 | 192 | 71 | 39 | 110 | 94 | 62 | 156 | ||||||||||||||||||
Non-investment grade residual securities | 126 | 2 | 128 | 245 | 26 | 271 | 113 | 4 | 117 | ||||||||||||||||||
Total thrift | 903 | 5,504 | 6,407 | 420 | 4,622 | 5,042 | 995 | 6,106 | 7,101 | ||||||||||||||||||
Total mortgage-backed securities | $ | 1,115 | $ | 5,504 | $ | 6,619 | $ | 631 | $ | 4,622 | $ | 5,253 | $ | 1,223 | $ | 6,106 | $ | 7,329 | |||||||||
AAA-rated MBS represented 83%, 85% and 83% of the total portfolio at March 31, 2008, and 2007, and December 31, 2007, respectively. These securities had an expected weighted average life of 4.4 years, 2.8 years and 3.0 years at March 31, 2008, 2007, and December 31, 2007, respectively. Due to downgrades of investment grade securities, we anticipate an increase in non-investment grade securities. Such an increase could require that we hold additional capital against these securities.
The capital markets have taken another turn for the worse with credit spreads widening significantly due to disrupted market conditions caused by uncertainty in the U.S. housing and mortgage markets, margin calls by Wall Street repo lenders on mortgage real estate investment trust and hedge funds, and other economic and financial uncertainties. As a result of this spread widening, the value of our MBS portfolio was adversely affected. We believe that most of any potential negative financial impact is not warranted by the present underlying performance and/or ratings of these assets and, therefore, any unrealized losses will likely reverse and have a positive financial impact in subsequent quarters, either when spreads tighten or over time via an increased asset yield. We have the intent and ability to continue to hold these assets to recovery as a result of funding our balance sheet with deposits, FHLB advances, long-term debt and equity.
During April 2008, Moody's Investor Services ("Moody's") and Standard & Poor's Rating Services ("S&P") downgraded the ratings on significant number of MBS backed by non-agency collateral, including certain of those issued by Indymac and for which Indymac has retained interests in its MBS portfolio. A total of 29 bonds with carrying value of $160 million were downgraded. These downgrades will negatively impact the Company's Tier 1 risk-based capital ratio and total risk-based capital ratio as of June 30, 2008, as the risk-weighting of MBS is dependent upon the ratings provided by these rating agencies. For valuation of our financial instruments, refer to "Earnings—Impact of Recent Changes in Fair Value Accounting in our Financial Results" section.
22
SFR MORTGAGE LOANS HFI DIVISION
The SFR mortgage HFI portfolio generates core spread income. These loans are priced to an ROE that exceeds our cost of capital and provides support for our Mortgage Banking Segment by providing liquidity. The portfolio has grown substantially in the previous two quarters as we have transferred non-GSE eligible loans into the portfolio that would have previously been sold in the secondary market.
The following provides a composition of the SFR mortgage loans HFI portfolio and the relevant credit quality characteristics as of the dates indicated (dollars in millions):
|
March 31 |
|
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
December 31, 2007 |
||||||||||
|
2008 |
2007 |
|||||||||
Outstanding balance(1) | $ | 11,965 | $ | 5,214 | $ | 11,411 | |||||
Average loan size | $ | 0.3 | $ | 0.3 | $ | 0.3 | |||||
Non-performing loans | 9.47 | % | 2.12 | % | 6.47 | % | |||||
Estimated average life in years(2) | 3.6 | 2.8 | 2.4 | ||||||||
Estimated average net duration in month(3) | 12.0 | (2.7 | ) | 2.1 | |||||||
Annualized yield | 6.35 | % | 6.21 | % | 7.03 | % | |||||
Percent of loans with active prepayment penalty | 42 | % | 38 | % | 43 | % | |||||
By Product Type: |
|||||||||||
Fixed-rate mortgages | 15 | % | 7 | % | 15 | % | |||||
Intermediate term fixed-rate loans | 11 | % | 14 | % | 15 | % | |||||
Interest-only loans | 43 | % | 55 | % | 43 | % | |||||
Pay option ARMs(4) | 29 | % | 22 | % | 26 | % | |||||
Others | 2 | % | 2 | % | 1 | % | |||||
100 | % | 100 | % | 100 | % | ||||||
Additional Information: | |||||||||||
Average FICO score | 694 | 714 | 693 | ||||||||
Original average LTV (First liens) | 76 | % | 73 | % | 76 | % | |||||
Current average LTV (First liens)(5) | 79 | % | 61 | % | 76 | % | |||||
Geographic distribution of top five states: | |||||||||||
Southern California | 30 | % | 34 | % | 30 | % | |||||
Northern California | 15 | % | 21 | % | 15 | % | |||||
Total California | 45 | % | 55 | % | 45 | % | |||||
Florida | 9 | % | 6 | % | 9 | % | |||||
New York | 7 | % | 4 | % | 7 | % | |||||
New Jersey | 3 | % | 2 | % | 3 | % | |||||
Maryland | 3 | % | 2 | % | 3 | % | |||||
Others | 33 | % | 31 | % | 33 | % | |||||
Total | 100 | % | 100 | % | 100 | % | |||||
23
CONSUMER CONSTRUCTION DIVISION
Our consumer construction division provides construction financing for individual consumers who want to build a new primary residence or second home. The primary product is a CTP residential mortgage loan. This product typically provides financing for a construction term from 6 to 12 months and automatically converts to a permanent mortgage loan at the end of construction. The end result is a loan product that represents a hybrid activity between our portfolio lending and mortgage banking activities. As of March 31, 2008, based on the underlying note agreements, 82% of the construction loans will be converted to adjustable-rate permanent loans, 12% to intermediate term fixed-rate loans, and 6% to fixed-rate loans.
The consumer construction division temporarily suspended all new CTP production on January 31, 2008 to help manage our balance sheet. Our consumer construction division had previously suspended lot and single spec production in 2007.
During the first quarter of 2008, we entered into new consumer construction commitments of $112 million, which is a decrease of 87%, or $730 million, from the first quarter of 2007 and a decrease of 71%, or $273 million, from the fourth quarter of 2007. Approximately 72% of new commitments are generated through mortgage professional customers, and the remaining 28% of new commitments are retail originations. Consumer construction loans outstanding at March 31, 2008 decreased 3% from March 31, 2007 and 6% from December 31, 2007.
We introduced a monthly adjusting construction period ARM product in 2006. The percentage of these adjustable-rate loans in our portfolio was 71% at March 31, 2008, compared to 39% and 72% at March 31, 2007 and December 31, 2007, respectively. The ratio of non-performing loans increased to 6.15% of the portfolio at March 31, 2008, compared to 1.23% and 3.31% at March 31, 2007 and December 31, 2007, respectively. The ratio of charged-off non-performing loans increased to 69% at March 31, 2008, compared to 59% and 29% at March 31, 2007 and December 31, 2007, respectively. Total charges taken against the portfolio was $22 million for the first quarter of 2008, up from $1 million and $12 million for the first quarter and fourth quarter of 2007, respectively. As a result, we adjusted the allowance for loan losses to $30 million at March 31, 2008, compared to $12 million and $32 million at March 31, 2007 and December 31, 2007, respectively. This resulted in a percentage of allowance for loan losses to recorded value of 1.36% at March 31, 2008, from 1.38% at December 31, 2007.
24
Information on our consumer construction portfolio is presented below as of the dates indicated (dollars in millions):
|
March 31 |
|
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
December 31, 2007 |
||||||||||
|
2008 |
2007 |
|||||||||
Outstanding balance | $ | 2,196 | $ | 2,275 | $ | 2,343 | |||||
Total commitments | $ | 3,080 | $ | 3,625 | $ | 3,504 | |||||
Average loan commitment | $ | 0.6 | $ | 0.5 | $ | 0.6 | |||||
Non-performing loans | 6.15 | % | 1.23 | % | 3.31 | % | |||||
By Product Type: |
|||||||||||
Fixed-rate loans | 29 | % | 61 | % | 28 | % | |||||
Adjustable-rate loans | 71 | % | 39 | % | 72 | % | |||||
100 | % | 100 | % | 100 | % | ||||||
Additional Information: | |||||||||||
Average LTV ratio(1) | 73 | % | 73 | % | 73 | % | |||||
Average FICO score | 722 | 712 | 722 | ||||||||
Geographic distribution of top five states: | |||||||||||
Southern California | 31 | % | 29 | % | 30 | % | |||||
Northern California | 13 | % | 14 | % | 12 | % | |||||
Total California | 44 | % | 43 | % | 42 | % | |||||
Florida | 7 | % | 8 | % | 7 | % | |||||
Washington | 5 | % | 4 | % | 4 | % | |||||
New York | 4 | % | 4 | % | 4 | % | |||||
Arizona | 4 | % | 3 | % | 4 | % | |||||
Others | 36 | % | 38 | % | 39 | % | |||||
Total | 100 | % | 100 | % | 100 | % | |||||
This segment contains the fixed costs of our deposit raising and treasury functions that are not allocated to our operating divisions, as well as entries to eliminate the impact of transactions between segments. In addition to selling loans into the secondary market, our mortgage production division regularly sells loans to our SFR mortgage loans HFI division. These transactions are recorded at arms-length in our segment results resulting in intercompany gain on sale in the mortgage production division and a premium in the SFR mortgage loans HFI division that is amortized over the life of the loan. Both the gain and the premium amortization are eliminated in consolidation.
The mortgage-backed securities division and the mortgage servicing division are exposed to movements in the intermediate fixed-rate non-agency loan spreads. Mortgage spread is the difference between mortgage interest rates and LIBOR/interest rate swap rates. Tighter spreads benefit mortgage-backed securities valuations while wider spreads lead to slower projected prepayment speeds and an increase in the MSR value. Due to the inherent difficulty in hedging the movement of these spreads, the potential for an internal hedge exists whereby the risks from the spread movements will be shared between the two groups. The mortgage production division and the mortgage servicing division have entered periodically into formal inter-divisional transactions to economically hedge their respective financial risks to mortgage spreads for certain products in the absence of readily available derivative instruments. The impact of the hedges has been reflected in the respective channel results with the consolidation adjustment recorded under "Interdivision Hedge Transactions" within "Eliminations".
25
The following provides additional details on deposits, treasury and eliminations for the periods indicated (dollars in millions):
|
|
|
Eliminations |
|
|||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Deposits |
Treasury |
Interdivision Loan Sales(1) |
Interdivision Hedge Transactions |
Other |
Total |
|||||||||||||||
Three Months Ended March 31, 2008 | |||||||||||||||||||||
Operating Results | |||||||||||||||||||||
Net interest income | $ | — | $ | 9.7 | $ | 2.7 | $ | — | $ | 10.7 | $ | 23.1 | |||||||||
Gain (loss) on sale of loans | — | — | (0.7 | ) | (9.5 | ) | (12.3 | ) | (22.5 | ) | |||||||||||
Service fee income | — | — | — | 111.9 | 3.6 | 115.5 | |||||||||||||||
Gain (loss) on securities | — | — | — | (102.4 | ) | — | (102.4 | ) | |||||||||||||
Other income | 0.9 | 0.2 | — | — | (1.4 | ) | (0.3 | ) | |||||||||||||
Net revenues (expense) | 0.9 | 9.9 | 2.0 | — | 0.6 | 13.4 | |||||||||||||||
Operating expenses | 6.5 | 11.6 | — | — | (2.1 | ) | 16.0 | ||||||||||||||
Pretax earnings (loss) | (5.6 | ) | (1.7 | ) | 2.0 | — | 2.7 | (2.6 | ) | ||||||||||||
Minority interests | — | 1.1 | — | — | — | 1.1 | |||||||||||||||
Net earnings (loss) | $ | (3.4 | ) | $ | (2.0 | ) | $ | 1.2 | $ | — | $ | 1.6 | $ | (2.6 | ) | ||||||
Three Months Ended March 31, 2007 |
|||||||||||||||||||||
Operating Results | |||||||||||||||||||||
Net interest income | $ | — | $ | 9.6 | $ | 9.1 | $ | — | $ | 5.6 | $ | 24.3 | |||||||||
Gain (loss) on sale of MBS | — | — | (14.9 | ) | (7.8 | ) | 0.5 | (22.2 | ) | ||||||||||||
Service fee income | — | — | — | 7.8 | (10.2 | ) | (2.4 | ) | |||||||||||||
Gain (loss) on securities | — | — | — | — | 0.7 | 0.7 | |||||||||||||||
Other income | 1.0 | 0.6 | — | — | (0.6 | ) | 1.0 | ||||||||||||||
Net revenues (expense) | 1.0 | 10.2 | (5.8 | ) | — | (4.0 | ) | 1.4 | |||||||||||||
Operating expenses | 6.5 | 11.7 | — | — | (4.0 | ) | 14.2 | ||||||||||||||
Pretax loss | (5.5 | ) | (1.5 | ) | (5.8 | ) | — | — | (12.8 | ) | |||||||||||
Net loss | $ | (3.4 | ) | $ | (0.9 | ) | $ | (3.2 | ) | $ | — | $ | — | $ | (7.5 | ) | |||||
As previously mentioned, we do not allocate fixed corporate overhead costs to our profit center divisions, because the methodologies to do so are arbitrary and distort each division's marginal contribution to our profits. These unallocated corporate overhead costs are reported in the corporate overhead segment. The after-tax loss from this segment decreased from a loss of $29 million in the first quarter of 2007 to a loss of $25 million in the first quarter of 2008.
DISCONTINUED BUSINESS ACTIVITIES AND RESTRUCTURING CHARGES
As conditions in the U.S. mortgage market have deteriorated, we exited certain production channels and are reporting them in a separate category in our segment reporting ("Discontinued Business Activities and Restructuring Charges"). These exited production channels include conduit, home equity and homebuilder channels. These activities are not considered discontinued operations as defined by SFAS 144 due to our significant continuing involvement in these activities. Of the $249 million in total credit costs we reported in the first quarter of 2008, $57 million were in these discontinued businesses, driving the total after-tax loss of $84 million for these discontinued businesses for the quarter. Also, embedded in this net loss was $44 million restructuring charges after-tax. There were no restructuring charges in the prior quarters. In January 2008, the Company initiated a program to reduce costs and improve operating efficiencies in response to the significant changes to its business model and market conditions.
26
The following provides details on the results of our exited businesses for the periods indicated (dollars in millions):
|
Discontinued Business Activities and Restructuring Charges |
|||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Conduit Channel |
Home Equity Division |
Homebuilder Division |
Prior Production Model |
Other |
Total |
||||||||||||||||
Three Months Ended March 31, 2008 | ||||||||||||||||||||||
Operating Results | ||||||||||||||||||||||
Net interest income (expense) | $ | (0.6 | ) | $ | 6.9 | $ | (0.1 | ) | $ | 0.6 | $ | 0.5 | $ | 7.3 | ||||||||
Provision for loan losses | — | (20.0 | ) | (15.0 | ) | — | (0.4 | ) | (35.4 | ) | ||||||||||||
Loss on sale of loans | (6.2 | ) | (2.6 | ) | — | (12.4 | ) | — | (21.2 | ) | ||||||||||||
Service fee income (expense) | — | 0.2 | — | — | — | 0.2 | ||||||||||||||||
Loss on securities | — | (2.6 | ) | — | — | — | (2.6 | ) | ||||||||||||||
Other income | — | 2.1 | — | — | — | 2.1 | ||||||||||||||||
Net revenues (expense) | (6.8 | ) | (16.0 | ) | (15.1 | ) | (11.8 | ) | — | (49.6 | ) | |||||||||||
Operating expenses | 8.6 | 2.6 | 6.1 | 5.3 | — | 22.6 | ||||||||||||||||
Restructuring charges | — | — | — | — | 72.4 | 72.4 | ||||||||||||||||
Pre-tax loss | (15.4 | ) | (18.6 | ) | (21.2 | ) | (17.1 | ) | (72.4 | ) | (144.6 | ) | ||||||||||
Minority interests | — | 0.6 | 0.2 | — | 0.1 | 0.9 | ||||||||||||||||
Net loss | $ | (9.4 | ) | $ | (12.1 | ) | $ | (13.1 | ) | $ | (10.5 | ) | $ | (39.3 | ) | $ | (84.4 | ) | ||||
Performance Data | ||||||||||||||||||||||
Average interest-earning assets | ||||||||||||||||||||||
Allocated capital | $ | 73.2 | $ | 1,890.3 | $ | 1,134.3 | $ | 71.0 | $ | 28.2 | $ | 3,197.0 | ||||||||||
Loans produced | 3.9 | 91.7 | 34.8 | 9.2 | 1.9 | 141.5 | ||||||||||||||||
Loans sold | — | 0.2 | — | — | — | 0.2 | ||||||||||||||||
MBR margin | 122.1 | 57.6 | — | — | — | 179.7 | ||||||||||||||||
ROE | (5.53 | )% | N/A | N/A | N/A | N/A | (11.78 | )% | ||||||||||||||
Net interest margin | N/M | (53 | )% | (152 | )% | (457 | )% | N/M | (240 | )% | ||||||||||||
Net interest margin, thrift | (3.04 | )% | 1.47 | % | (0.04 | )% | 3.09 | % | 6.52 | % | 0.91 | % | ||||||||||
Efficiency ratio | N/A | 68 | % | N/M | N/A | 4 | % | (159 | )% | |||||||||||||
Average FTE | 6 | 56 | 78 | 3 | — | 143 | ||||||||||||||||
Three Months Ended March 31, 2007 |
||||||||||||||||||||||
Operating Results | ||||||||||||||||||||||
Net interest income | $ | 20.1 | $ | 7.0 | $ | 15.1 | $ | — | $ | 0.5 | $ | 42.7 | ||||||||||
Provision for loan losses | — | (0.2 | ) | — | — | (0.5 | ) | (0.7 | ) | |||||||||||||
Gain (loss) on sale of loans | (9.9 | ) | 8.1 | — | — | — | (1.8 | ) | ||||||||||||||
Service fee income | — | 0.5 | — | — | — | 0.5 | ||||||||||||||||
Loss on securities | — | (4.1 | ) | — | — | — | (4.1 | ) | ||||||||||||||
Other income (expense) | (0.1 | ) | 1.6 | 0.3 | — | — | 1.8 | |||||||||||||||
Net revenues (expense) | 10.1 | 12.9 | 15.4 | — | — | 38.4 | ||||||||||||||||
Operating expenses | 8.7 | 4.6 | 6.1 | — | — | 19.4 | ||||||||||||||||
Deferral of expenses under SFAS 91 | — | (0.3 | ) | (1.7 | ) | — | — | (2.0 | ) | |||||||||||||
Pre-tax earnings | 1.4 | 8.6 | 11.0 | — | — | 21.0 | ||||||||||||||||
Net earnings | $ | 0.8 | $ | 5.3 | $ | 6.7 | $ | — | $ | — | $ | 12.8 | ||||||||||
Performance Data | ||||||||||||||||||||||
Average interest-earning assets | $ | 5,724.1 | $ | 1,563.7 | $ | 1,182.1 | $ | — | $ | 34.5 | $ | 8,504.4 | ||||||||||
Allocated capital | 239.4 | 122.9 | 106.8 | — | 3.2 | 472.3 | ||||||||||||||||
Loans produced | 8,367.6 | 24.6 | 359.8 | — | — | 8,752.0 | ||||||||||||||||
Loans sold | 8,255.0 | 740.3 | — | — | — | 8,995.3 | ||||||||||||||||
MBR margin | 0.12 | % | N/A | N/A | — | N/A | 0.20 | % | ||||||||||||||
ROE | 1 | % | 17 | % | 26 | % | — | (4 | )% | 11 | % | |||||||||||
Net interest margin | 1.42 | % | 1.82 | % | 5.19 | % | — | 5.86 | % | 2.04 | % | |||||||||||
Net interest margin, thrift | N/A | N/A | N/A | — | N/A | N/A | ||||||||||||||||
Efficiency ratio | N/A | 33 | % | 28 | % | — | 11 | % | 44 | % | ||||||||||||
Average FTE | 177 | 82 | 125 | — | — | 384 | ||||||||||||||||
Year to Year Comparison |
||||||||||||||||||||||
% change in net earnings | N/M | (328 | )% | (295 | )% | N/A | N/M | N/M | ||||||||||||||
% change in capital | (98 | )% | (25 | )% | (67 | )% | N/A | (39 | )% | (70 | )% |
27
The conduit channel purchased pools of closed loans for portfolio, resale, or securitization and this channel was characterized by its low cost operations and quick asset turn times. For the quarter ended March 31, 2008, there were no loans produced by our discontinued conduit channel, as compared to $8.4 billion and $57 million for the quarters ended March 31, 2007 and December 31, 2007, respectively. We exited this channel in the fourth quarter of 2007 due to its inherently lower profit margins and the current uncertainty with respect to secondary market spreads and execution. The conduit channel recorded a net loss of $9 million for the quarter ended March 31, 2008, from net earnings of $1 million for the quarter ended March 31, 2007 and from a net loss of $49 million for the quarter ended December 31, 2007.
The home equity division provides HELOC and closed-end second mortgages nationwide through our mortgage professionals and retail channels. We ceased new originations in this division from all but our retail deposit branches in the fourth quarter of 2007 as a response to extreme disruptions in the housing and mortgage markets.
At March 31, 2008, our total HELOC servicing portfolio amounted to $4.1 billion, an increase of approximately $239 million from March 31, 2007 and a decrease of approximately $125 million from December 31, 2007. We produced $42 million of new HELOC commitments through our mortgage banking segment and internal channels during the first quarter of 2008, sold $58 million and realized a net loss on sale of $3 million. During the first quarter of 2007, we produced $725 million of HELOC loans and sold $740 million with a corresponding net gain on sale of $8 million. In the fourth quarter of 2007, we produced $280 million of new HELOC commitments, sold $68 million and realized a net loss on sale of $83 million.
Our HELOC securitization agreements contain provisions that, under certain circumstances, the securitization enters a "rapid amortization period". During this period, all new draws on revolving HELOC loans are allocated to a seller's interest on our consolidated balance sheets. This causes the outstanding bonds to pay down quickly.
Our securitization agreements generally treat our seller's interest as "pari passu" to the securitization trust. Accordingly, any cash received on the underlying loans is distributed on a pro-rata basis, and our seller's interest is not subordinated to the securitization trust, even in rapid amortization. As of March 31, 2008, none of our securitizations were in a rapid amortization period. Since our seller's interest is not subordinated, the expected impact on our financial statements is projected to be a modest increase in HELOC loans outstanding, which will likely be offset by the run-off in the existing HFI portfolio.
All HELOC loans are adjustable-rate loans and indexed to the prime rate. Information on the combined HELOC portfolio, including both HFS and HFI loans, is presented as of the dates indicated (dollars in millions):
|
March 31 |
|
||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
December 31, 2007 |
|||||||||
|
2008 |
2007 |
||||||||
Outstanding balance(1) | $ | 1,498 | $ | 366 | $ | 1,460 | ||||
Total commitments(2) | $ | 2,840 | $ | 1,445 | $ | 2,911 | ||||
Average spread over prime | 1.13 | % | 1.42 | % | 1.16 | % | ||||
Average FICO score(3) | 729 | 738 | 736 | |||||||
Average combined LTV ratio(4) | 77 | % | 76 | % | 77 | % |
28
The following contains some additional information in our HELOC portfolio as of the dates indicated (dollars in millions):
|
Outstanding Balance |
Average Loan Commitment Balance |
Average Spread Over Prime |
Current Average FICO |
30+ Days Delinquency %(1) |
||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
March 31, 2008 | |||||||||||||
Combined LTV | |||||||||||||
96% to 100% | $ | 65 | $ | 0.08 | 2.42 | % | 699 | 10.81 | % | ||||
91% to 95% | 236 | 0.08 | 1.73 | % | 707 | 6.71 | % | ||||||
81% to 90% | 495 | 0.07 | 1.51 | % | 710 | 6.54 | % | ||||||
71% to 80% | 409 | 0.12 | 0.59 | % | 738 | 3.61 | % | ||||||
70% or less | 293 | 0.13 | 0.39 | % | 750 | 2.43 | % | ||||||
Total | $ | 1,498 | 0.10 | 1.13 | % | 729 | 5.15 | % | |||||
March 31, 2007 | |||||||||||||
Combined LTV | |||||||||||||
96% to 100% | $ | 41 | $ | 0.11 | 2.48 | % | 718 | 11.00 | % | ||||
91% to 95% | 64 | 0.09 | 2.21 | % | 715 | 2.77 | % | ||||||
81% to 90% | 136 | 0.09 | 1.70 | % | 719 | 3.17 | % | ||||||
71% to 80% | 70 | 0.15 | 0.41 | % | 747 | 1.55 | % | ||||||
70% or less | 55 | 0.15 | 0.26 | % | 754 | 0.56 | % | ||||||
Total | $ | 366 | 0.12 | 1.42 | % | 738 | 3.27 | % | |||||
The rapid deterioration in the real estate markets and the ongoing disruption in the mortgage market nationwide continue to have a significant impact on our homebuilder borrowers and portfolio of loans. The homebuilder division continues to workout its portfolio of performing and non-performing loans toward pay-off or eventual foreclosure and sale. Effective fourth quarter of 2007, we ceased new originations and do not anticipate being in this business once all loans and/or REO are paid-off or liquidated. We are monitoring this portfolio very closely, as the housing markets are expected to continue to weaken, which affects both the underlying collateral values and the projected repayment sources for these loans. Accordingly, we expect to have additional downgrades, provisions for loan losses, and charge-offs relating to this portfolio.
Adversely classified assets were $761 million, or 72% of the outstanding balance at March 31, 2008, up from $112 million, or 10%, and $675 million, or 56%, of the outstanding balances at March 31, 2007 and December 31, 2007, respectively. At March 31, 2008, non-performing loans rose to $552 million, up from $9 million and $480 million at March 31, 2007 and December 31, 2007, respectively.
The increase in non-performing loans and adversely classified assets resulted in a provision to the allowance for loan losses of $15 million for the first quarter of 2008, or 1.32% of average loans, up from a zero provision for the first quarter of 2007 but down from $99 million, or 8.21% of average loans, for the fourth quarter of 2007. The total allowance for loan losses increased to $204 million, or 19.3% of the outstanding balance of total loans, at March 31, 2008, up from $20 million, or 1.74% of the outstanding balance of total loans and $199 million, or 16.66% of the outstanding balance of total loans, at March 31,
29
2007 and December 31, 2007, respectively. There were charge-offs of $10 million during the first quarter of 2008, while there were no charge-offs during the quarters ended March 31, 2007 and December 31, 2007. There were REO of $33 million at March 31, 2008, while there were no REO at March 31, 2007 and December 31, 2007.
Information on our homebuilder portfolio is presented below as of the dates indicated (dollars in millions):
|
March 31 |
|
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
December 31, 2007 |
||||||||||
|
2008 |
2007 |
|||||||||
Outstanding balance | $ | 1,056 | $ | 1,173 | $ | 1,192 | |||||
Total commitments | $ | 1,362 | $ | 1,967 | $ | 1,662 | |||||
Average loan commitments | $ | 8 | $ | 10 | $ | 8 | |||||
Non-performing loans | 52.26 | % | 0.77 | % | 40.28 | % | |||||
REO | $ | 33 | $ | — | $ | — | |||||
Allowance for loan losses as a percentage of recorded value | 19.30 | % | 1.74 | % | 16.66 | % | |||||
Additional Information: |
|||||||||||
Geographic distribution of top five states: | |||||||||||
Southern California | 41 | % | 42 | % | 37 | % | |||||
Northern California | 30 | % | 22 | % | 29 | % | |||||
Total California | 71 | % | 64 | % | 66 | % | |||||
Florida | 7 | % | 10 | % | 10 | % | |||||
Illinois | 6 | % | 8 | % | 7 | % | |||||
Oregon | 4 | % | 5 | % | 4 | % | |||||
Arizona | 3 | % | 2 | % | 3 | % | |||||
Others | 9 | % | 11 | % | 10 | % | |||||
Total | 100 | % | 100 | % | 100 | % | |||||
CONSOLIDATED RISK MANAGEMENT DISCUSSION
We manage many types of risks with several layers of risk management and oversight, using both a centralized and decentralized approach. Our philosophy is to put risk management at the core of our operations and establish a unified framework for measuring and managing risk across the enterprise, providing our business units with the tools—and accountability—to manage risk. At the corporate level, this consolidated risk management is known as Enterprise Risk Management ("ERM"). ERM, in partnership with the Board of Directors and senior management, provide support to and oversight of the business units.
ERM, as a part of management, develops, maintains and monitors our cost effective yet comprehensive enterprise-wide risk management framework, including our system of operating internal controls. ERM fosters a risk management culture throughout Indymac and exists to help us manage unexpected losses, earnings surprises and reputation damage. It also provides management and the Board with a better understanding of the trade-offs between risks and rewards, leading to smarter investment decisions and more consistent and generally higher long-term returns on equity.
CAMELS FRAMEWORK FOR RISK MANAGEMENT
The framework for organizing ERM is based on the six-point rating scale used by the Office of Thrift Supervision ("OTS"), our regulating body, to evaluate the financial condition of savings and loan associations. A discussion of the areas covered by CAMELS (Capital, Asset Quality, Management, Earnings, Liquidity and Sensitivity to Market Risk) follows. See the "Risk Factors" section for risks related to deterioration in our regulatory capital position.
30
The Bank is subject to regulatory capital regulations administered by the federal banking agencies. As of March 31, 2008, the Bank met all of the requirements of a "well-capitalized" institution under the general regulatory capital regulations.
Our business is primarily centered on single-family lending and the related production and sale of loans. Due to the disruption of the secondary markets, loan sales were adversely impacted, resulting in lower than normal volume. Thus, we significantly changed our production model and transitioned to primarily become a GSE lender.
The accumulation of MSRs is a large component of our strategy. As of March 31, 2008, the capitalized value of MSRs was $2.6 billion. OTS regulations effectively impose higher capital requirements on the amount of MSRs that exceeds total Tier 1 capital. These higher capital requirements could result in lowered returns on our retained assets and could limit our ability to retain servicing assets and even cause our capital levels to decline significantly if the value of our MSRs grows.
The following presents Indymac Bank's actual and the minimum required capital ratios to be categorized as "well-capitalized" as of March 31, 2008 (dollars in millions):
|
Capital Ratios |
||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Tangible |
Tier 1 Core |
Tier 1 Risk-Based |
Total Risk-Based |
|||||||||
As reported on Thrift Financial Report(1) | 5.74 | % | 5.74 | % | 9.00 | % | 10.26 | % | |||||
Well-capitalized minimum requirement | 2.00 | % | 5.00 | % | 6.00 | % | 10.00 | % | |||||
Excess over well-capitalized minimum requirement | $ | 1,198 | $ | 238 | $ | 547 | $ | 47 |
Second, the regulations require us to exclude from our Tier 2 capital the portion of our allowance for loan losses (ALL) that exceeds the 1.25 percent of risk-weighted assets limitation. If we were further allowed to include in Tier 2 capital our ALL that exceeds 1.25% of our risk-weighted assets (in addition to the MSR waiver requested above), our capital ratios would be 6.07% Tier 1 core, 9.47% Tier 1 risk-based and 11.36% total risk-based.
During April 2008, Moody's Investor Services ("Moody's") and Standard & Poor's Rating Services ("S&P") downgraded the ratings on significant number of MBS backed by non-agency collateral, including certain of those issued by Indymac and for which Indymac has retained interests in its MBS portfolio. A total of 29 bonds with carrying value of $160 million were downgraded. These downgrades will negatively impact the Company's Tier 1 risk-based capital ratio and total risk-based capital ratio as of June 30, 2008, as the risk-weighting of MBS is dependent upon the ratings provided by these rating agencies. Had these lowered ratings been in effect at March 31, 2008, our capital ratios would have been 5.74% Tier 1 core, 8.01% Tier 1 risk-based and 9.27% total risk-based.
31
The Bank's regulatory capital compliance could be impacted by a number of factors, such as changes to applicable regulations, adverse action by our regulators, changes in our mix of assets, decline in real estate values, interest rate fluctuations, loan loss provisions and credit losses, or significant changes in the economy in areas where we have most of our loans, or future disruptions in the secondary mortgage market or MBS market. Any of these factors could cause actual future results to vary from anticipated future results and consequently could have an adverse impact on the ability of the Bank to meet its future minimum capital requirements. There are scenarios where we could be adequately capitalized during this crisis; regulatory response to being adequately capitalized is not known.
We are currently forecasting that our balance sheet size will decline and our capital ratios will increase over the course of 2008 as we execute on our revised business model of primarily GSE lending. In addition, the Company has been raising capital in its DSPP. Total capital raised with DSPP in the first quarter of 2008 was $39 million and year-to-date through May 9, 2008 the Company has raised $97 million.
The banking industry, in general, is heavily regulated. As a savings and loan holding company, we are subject to regulation by the OTS, and Indymac Bank is subject to regulation by the OTS and the Federal Deposit Insurance Corporation ("FDIC"). As noted above, OTS regulations specify minimum capital ratio requirements that must be maintained by a savings association to be considered a "well-capitalized" institution. A "well-capitalized" savings association must have a total risk-based capital ratio of at least 10% of risk-weighted assets, a Tier 1 risk-based capital ratio of at least 6% of risk-weighted assets, and a Tier 1 (core) capital ratio (sometime known as the "leverage ratio") of at least 5% of adjusted total assets. A savings association that falls below any one of these thresholds must maintain total risk-based capital of 8%, Tier 1 risk-based capital of 4%, and a Tier 1 (core) capital ratio of 4% in order to be considered "adequately capitalized." If any of the ratios fall below the "adequately capitalized" levels, then the association is deemed "undercapitalized" and becomes subject to various automatic and discretionary remedial actions by the OTS. As of March 31, 2008, Indymac Bank met all of the requirements of a "well-capitalized" institution under the prompt corrective action and regulatory capital regulations. However, there can be no assurances that we will be able to maintain the status of a "well-capitalized" institution in the future.
If our regulatory capital position were to deteriorate such that we were classified as an "adequately capitalized" institution, we might not be able to use brokered deposits as a source of funds. A "well-capitalized" savings association or bank may accept brokered deposits without restriction. An "adequately capitalized" savings association must obtain a waiver from the FDIC in order to accept, renew or roll over brokered deposits. In addition, certain interest-rate limits apply to the association's brokered and solicited deposits. Our brokered and solicited deposits represent funds that brokers gather from third parties and package in batches or that we solicit directly and on which we pay higher interest rates than are typically available for certificates of deposits. Although an institution could seek permission from the FDIC to accept brokered deposits if it were no longer considered to be a "well-capitalized" institution, the FDIC may deny permission, or may permit the institution to accept fewer brokered deposits than the level considered desirable. Even with a waiver, the interest rate limitations on brokered and solicited deposits could have the effect of reducing demand for some of the deposit products. If our level of deposits were to be reduced, either by the lack of a full brokered deposit waiver or by the interest rate limits on brokered or solicited deposits, we anticipate that we would reduce our assets and, most likely, curtail our lending activities. Other possible consequences of classification as an "adequately capitalized" institution include the potential for increases in our borrowing costs and terms from the FHLB and other financial institutions, as well as in our premiums to the Deposit Insurance Fund administered by the FDIC to insure bank and savings association deposits and in our assessment payments to OTS. Such changes could have an adverse effect on our operations.
In addition, the OTS and the FDIC have broad discretion to impose various restrictions or remedial requirements upon us when they deem it appropriate which may adversely affect our operations. Although
32
we are not currently under any such restrictions or subject to any such remedial requirements, such supervisory restrictions may include:
Capital Management and Allocation
As a federally regulated thrift, we are required to measure regulatory capital using two different methods: core capital and risk-based capital. Under the core capital method, a fixed percentage of capital is required against each dollar of assets without regard to the type of asset. Under the risk-based capital method, capital is held against assets which are adjusted for their relative credit risk using standard "risk weighting" percentages. We allocate capital using the regulatory minimums for well-capitalized institutions for each applicable asset class. The ratios are below the regulatory minimums due to the use of trust preferred securities as a form of regulatory capital.
33
The following provides information on the core and risk-based capital ratios for the two segments and each of their operating divisions for the three months ended March 31, 2008 (dollars in millions):
|
Total Assets |
Core |
Risk-Based |
|||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Average Assets |
% of Total Assets |
Avg. Allocated Capital |
% of Total Capital |
Capital/ Assets |
ROE |
Avg. Allocated Capital |
% of Total Capital |
Capital/ Assets |
ROE |
||||||||||||||
Mortgage Banking Segment: | ||||||||||||||||||||||||
Retail | $ | 496.8 | 1.4 | % | $ | 16.0 | 1.2 | % | 3.2 | % | (314 | )% | $ | 24.8 | 1.9 | % | 5.0 | % | (203 | )% | ||||
Mortgage Professionals | 1,851.4 | 5.4 | % | 59.3 | 4.6 | % | 3.2 | % | (45 | )% | 64.2 | 5.0 | % | 3.5 | % | (42 | )% | |||||||
Financial Freedom | 997.8 | 2.9 | % | 109.3 | 8.4 | % | 11.0 | % | 7 | % | 106.9 | 8.2 | % | 10.7 | % | 7 | % | |||||||
Total Production Division | 3,346.0 | 9.7 | % | 184.6 | 14.2 | % | 5.5 | % | (37 | )% | 195.9 | 15.2 | % | 5.9 | % | (36 | )% | |||||||
Mortgage Servicing Rights | 3,428.7 | 10.0 | % | 217.7 | 16.8 | % | 6.4 | % | 29 | % | 321.5 | 24.8 | % | 9.4 | % | 19 | % | |||||||
Servicing/Customer Retention | 797.4 | 2.3 | % | 25.6 | 2.0 | % | 3.2 | % | 69 | % | 27.3 | 2.1 | % | 3.4 | % | 64 | % | |||||||
Total Mortgage Servicing Division | 4,226.1 | 12.3 | % | 243.3 | 18.8 | % | 5.8 | % | 33 | % | 348.8 | 26.9 | % | 8.3 | % | 23 | % | |||||||
Mortgage Bank Overhead | 69.3 | 0.2 | % | 2.2 | 0.2 | % | 3.2 | % | N/A | 8.4 | 0.6 | % | 12.1 | % | N/A | |||||||||
Total Consumer Mortgage Banking | 7,641.4 | 22.2 | % | 430.1 | 33.2 | % | 5.6 | % | (6 | )% | 553.1 | 42.7 | % | 7.2 | % | (5 | )% | |||||||
Commercial Mortgage Banking | 333.6 | 1.0 | % | 10.7 | 0.8 | % | 3.2 | % | (47 | )% | 21.5 | 1.7 | % | 6.5 | % | (24 | )% | |||||||
Total Mortgage Banking | 7,975.0 | 23.2 | % | 440.8 | 34.0 | % | 5.5 | % | (7 | )% | 574.6 | 44.4 | % | 7.2 | % | (6 | )% | |||||||
Thrift: | ||||||||||||||||||||||||
Investment grade securities | 6,706.1 | 19.5 | % | 214.9 | 16.6 | % | 3.2 | % | (2 | )% | 90.7 | 7.0 | % | 1.4 | % | (7 | )% | |||||||
Non-investment grade and residuals | 432.3 | 1.3 | % | 13.8 | 1.1 | % | 3.2 | % | (304 | )% | 129.3 | 10.0 | % | 29.9 | % | (32 | )% | |||||||
Total Mortgage-Backed Securities | 7,138.4 | 20.8 | % | 228.7 | 17.7 | % | 3.2 | % | (21 | )% | 220.0 | 17.0 | % | 3.1 | % | (22 | )% | |||||||
SFR mortgage loans HFI division | 11,923.4 | 34.7 | % | 382.0 | 29.5 | % | 3.2 | % | (43 | )% | 365.2 | 28.2 | % | 3.1 | % | (45 | )% | |||||||
Consumer construction division | 2,484.7 | 7.2 | % | 79.6 | 6.1 | % | 3.2 | % | (53 | )% | 78.6 | 6.1 | % | 3.2 | % | (54 | )% | |||||||
Warehouse Lending division | 74.4 | 0.2 | % | 2.4 | 0.2 | % | 3.2 | % | (25 | )% | 4.6 | 0.4 | % | 6.2 | % | (13 | )% | |||||||
Total Thrift Segment | 21,620.9 | 62.9 | % | 692.7 | 53.5 | % | 3.2 | % | (36 | )% | 668.4 | 51.7 | % | 3.1 | % | (38 | )% | |||||||
Consumer Bank—Deposits | 49.0 | 0.1 | % | 1.6 | 0.1 | % | 3.2 | % | N/A | 1.5 | 0.1 | % | 3.1 | % | N/A | |||||||||
Treasury | — | — | — | — | N/A | N/A | — | — | N/A | N/A | ||||||||||||||
Eliminations | — | — | — | — | N/A | N/A | — | — | N/A | N/A | ||||||||||||||
Total Operating | 29,644.9 | 86.2 | % | 1,135.1 | 87.6 | % | 3.8 | % | (27 | )% | 1,244.5 | 96.2 | % | 4.2 | % | (24 | )% | |||||||
Corporate overhead | 1,588.6 | 4.8 | % | 61.0 | 4.8 | % | 3.8 | % | N/A | (91.1 | ) | (7.1 | )% | (5.7 | )% | N/A | ||||||||
Total On-Going Businesses | 31,233.5 | 91.0 | % | 1,196.1 | 92.4 | % | 3.8 | % | (34 | )% | 1,153.4 | 89.1 | % | 3.7 | % | (35 | )% | |||||||
Discontinued Business Activities and Restructuring Charges: | ||||||||||||||||||||||||
Prior Production Model | 128.6 | 0.4 | % | 4.1 | 0.3 | % | 3.2 | % | N/M | 9.2 | 0.7 | % | 7.2 | % | (457 | )% | ||||||||
Conduit | 79.1 | 0.2 | % | 2.5 | 0.2 | % | 3.2 | % | N/M | 3.9 | 0.3 | % | 4.9 | % | N/M | |||||||||
Home equity division | 1,898.1 | 5.5 | % | 61.0 | 4.7 | % | 3.2 | % | (79 | )% | 91.7 | 7.1 | % | 4.8 | % | (53 | )% | |||||||
Homebuilder division | 949.0 | 2.8 | % | 30.4 | 2.3 | % | 3.2 | % | (173 | )% | 34.8 | 2.7 | % | 3.7 | % | (152 | )% | |||||||
Other | 23.9 | 0.1 | % | 0.8 | 0.1 | % | 3.2 | % | N/M | 1.9 | 0.1 | % | 8.0 | % | N/M | |||||||||
Total Discontinued Business Activities and Restructuring Charges | 3,078.7 | 9.0 | % | 98.8 | 7.6 | % | 3.2 | % | (343 | )% | 141.5 | 10.9 | % | 4.6 | % | (240 | )% | |||||||
Total Company | $ | 34,312.2 | 100.0 | % | $ | 1,294.9 | 100.0 | % | 3.8 | % | (57 | )% | $ | 1,294.9 | 100.0 | % | 3.8 | % | (57 | )% | ||||
As the table shows, certain asset types require more or less capital depending on the capital measurement method. For example, non-investment grade and residual securities are allocated 3.2% core capital and 29.9% risk-based capital. These differing methods result in significantly different ROEs as shown. We attempt to manage our business segments and balance sheet to optimize capital efficiency under both capital methods.
34
Indymac uses both a centralized and a decentralized approach to credit risk management. At the corporate level, ERM oversees the development of a framework (through people, policies and processes) for credit risk management that the business unit leaders use to document and "matrix manage" their credit and fraud risk. This framework includes the establishment and enforcement of strong corporate credit governance to maintain investment, lending and fraud policies that are simple, but highly effective. Each business unit has its own chief credit officer to oversee and implement these procedures. By tracking historical credit losses and factors contributing to the losses, we continuously implement changes to significantly reduce the likelihood of similar losses repeating. This ongoing analysis of credit performance provides a feedback loop that serves to continually refine and enhance credit risk policies.
We assume risk through our origination of loans, investments in whole loans and mortgage securities, and our construction lending operations. As a result of standard representations and warranties to investors, we also retain credit exposure from repurchase obligations on certain types of mortgage sales.
The following is a summary of reserves against our key credit risks as of March 31, 2008 (in millions):
Credit Risk Area |
Reserve Type |
Balance |
"Reserve" Balance |
UPB |
|||||||
---|---|---|---|---|---|---|---|---|---|---|---|
Mortgage Banking: | |||||||||||
Loans held for sale, excludes $2,411 million at fair value(1) | Market valuation reserve | $ | 914 | $ | — | $ | 899 | ||||
Repurchase risk(2) | Secondary market reserve | N/A | 188 | 184,535 | |||||||
Thrift: | |||||||||||
Loans held for investment(3) | Allowance for loan losses and estimated credit losses embedded in basis reductions due to loans transferred from HFS | 16,726 | 964 | 16,851 | |||||||
Non-investment grade and residual securities(4) | Loss assumption in valuations | 320 | 1,407 | 22,562 | |||||||
Foreclosed assets | Reduction in book value due to liquidation costs and/or property value deterioration | 257 | 120 | 377 | |||||||
Total Credit Reserves | $ | 2,679 | |||||||||
Loans are generally placed on non-accrual status when they are 90 days past due. Non-performing assets include non-performing loans and foreclosed assets. We record the balance of our assets acquired in foreclosure or by deed in lieu of foreclosure at estimated net realizable value.
35
The following summarizes our non-performing assets as of the dates indicated (dollars in millions):
|
March 31 |
|
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
December 31, 2007 |
||||||||||
|
2008 |
2007 |
|||||||||
Non-performing loans HFI | $ | 1,847 | $ | 154 | $ | 1,308 | |||||
Non-performing loans HFS(1) | — | 137 | 6 | ||||||||
Total non-performing loans | 1,847 | 291 | 1,314 | ||||||||
REO | 257 | 33 | 196 | ||||||||
Total non-performing assets | $ | 2,104 | $ | 324 | $ | 1,510 | |||||
Past due 90 days or more as to interest or principal and accruing interest | $ | 3 | $ | 0.7 | $ | 4 | |||||
Total non-performing assets to total assets | 6.51 | % | 1.09 | % | 4.61 | % | |||||
At March 31, 2008, non-performing assets as a percentage of total assets was 6.51%, increasing from 1.09% and 4.61% at March 31, 2007 and December 31, 2007, respectively. The weakening real estate market and the general tightening of underwriting in the mortgage industry continue to have a negative impact on our portfolios. It became increasingly difficult for distressed borrowers to find alternative financing in order to avoid foreclosure. This resulted in a higher percentage of loans going through foreclosure and a longer average time for us to liquidate our REO. We expect to have an even higher level of non-performing loans in the future due to the continued market disruption.
Non-performing loans held for investment increased by $539 million from December 31, 2007 to $1.8 billion at March 31, 2008, while non-performing loans held for sale decreased by $6 million from December 31, 2007. As a result of the increased delinquencies in these portfolios, foreclosure activities rose during the period, leading to REO of $257 million at March 31, 2008.
The following provides additional comparative data on non-performing loans for the loans HFI portfolio by division as of the dates indicated (in millions):
|
March 31 |
|
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
|
December 31, 2007 |
|||||||||||
|
2008 |
2007 |
||||||||||
SFR mortgage loans HFI | $ | 1,117 | $ | 107 | $ | 736 | ||||||
Consumer construction | 135 | 29 | 78 | |||||||||
Warehouse lending | — | 1 | — | |||||||||
Total on-going businesses | 1,252 | 137 | 814 | |||||||||
Homebuilder | 552 | 9 | 480 | |||||||||
Other(1) | 43 | 8 | 14 | |||||||||
Total discontinued business activities | 595 | 17 | 494 | |||||||||
Total non-performing loans HFI | $ | 1,847 | $ | 154 | $ | 1,308 | ||||||
Allowance for loan losses to non-performing loans HFI(2) | 26 | % | 44 | % | 30 | % | ||||||
36
The increase in non-performing HFI loans is mainly seen in the SFR mortgage loans HFI division and the homebuilder division portfolios. As previously noted, the increase in non-performing loans in our SFR mortgage loans HFI division portfolio is primarily due to the delinquency worsening credit environment and declining home prices primarily as it relates to higher LTV products. The non-performing loans in our homebuilder division's portfolio are in markets that have seen both price and sales declines. For further discussion on this portfolio, see "Summary of Business Segment Results—Discontinued Business Activities—Homebuilder Division".
Our non-accrual/non-performing loans by collateral type are summarized as follows (in millions):
|
March 31 |
|
|||||||
---|---|---|---|---|---|---|---|---|---|
|
December 31, 2007 |
||||||||
|
2008 |
2007 |
|||||||
Homebuilder loans | $ | 552 | $ | 9 | $ | 480 | |||
Consumer construction loans | 135 | 28 | 78 | ||||||
SFR mortgage loans HFI and other non-accrual/non-performing loans | 1,160 | 254 | 756 | ||||||
Total non-accrual/non-performing loans | $ | 1,847 | $ | 291 | $ | 1,314 | |||
As of March 31, 2008, non-accrual/non-performing loans include $865 million contractual unpaid principal balances ("UPB") and $698 million carrying amounts of transferred mortgage loans which had characteristics that were indicative of a significant change in credit quality since their origination date.
Of the total non-accrual loans at March 31, 2008, $552 million of homebuilder loans were accounted for in accordance with SFAS 114, "Accounting by Creditors for Impairment of a Loan" ("SFAS 114"). As of December 31, 2007, there were $480 million of homebuilder loans accounted for in accordance with SFAS 114. For the quarters ended March 31, 2008 and December 31, 2007, the average balance for the SFAS 114 impaired loans was $237 million and $127 million, respectively. The allowance for loan losses related to those SFAS 114 impaired loans was $122 million and $95 million at March 31, 2008 and December 31, 2007, respectively. For the quarters ended March 31, 2008 and December 31, 2007, no interest income was recognized on the SFAS 114 impaired loans once they were impaired. There were no significant non-accrual loans accounted for under SFAS 114 at March 31, 2007.
Troubled debt restructurings ("TDRs"), where management has granted a concession to a borrower experiencing financial difficulty, were approximately $269 million and $33 million as of March 31, 2008, and December 31, 2007, respectively. This includes approximately $180 million and $9 million of TDRs as of March 31, 2008 and December 31, 2007, respectively, that are not included as part of the total non-accrual/non-performing loans. We have no significant commitments to lend additional funds to borrowers with restructured loans.
For the loans held for investment portfolio, ALL is established and allocated to various loan types for segment reporting purposes. The determination of the level of the allowance for loan losses and, correspondingly, the provision for loan losses, is based on delinquency trends, prior loan loss experience, and management's judgment and assumptions regarding various matters, including general economic conditions and loan portfolio composition. Management continuously evaluates these assumptions and various relevant factors impacting credit quality and inherent losses. A component of the overall allowance for loan losses is not specifically allocated ("unallocated component"). The unallocated component reflects management's assessment of various factors that create inherent imprecision in the methods used to determine the specific portfolio allocations. Those factors include, but are not limited to, levels of and trends in delinquencies and impaired loans, charge-offs and recoveries, volume and terms of the loans, effects of any changes in risk selection and underwriting standards, other changes in lending policies, procedures, and practices, and national and local economic trends and conditions. As of March 31, 2008,
37
the unallocated component of the total allowance for loan losses was $30 million, compared to $73 million at December 31, 2007.
In the fourth quarter of 2007, the Company transferred mortgage loans with a net investment of $10.9 billion from HFS to HFI at the lower of cost or fair value as the Company no longer intended to sell these loans in the secondary market. These mortgage loans were transferred at LOCOM and the mortgage loans carrying value of $10.3 billion included a $0.6 billion impairment loss recorded as a component of gain/(loss) on sale primarily during the third and fourth quarters of 2007. A portion of the valuation reduction in net investment represents credit losses we estimated in determining the market value of these loans.
Of the contractual UPB of $10.7 billion transferred mortgages, $3.2 billion contractual UPB of these transferred mortgage loans had characteristics that were indicative of a significant change in credit quality since their origination date. The difference between the contractual UPB and the carrying amount determined as of transfer date is attributable predominantly to credit considerations, specifically expected losses on uncollectible principal balances. To the extent the Company determines the remaining future anticipated cash flows on this pool of mortgage loans have declined below the original estimate as of transfer date, an impairment is recognized through the allowance for loan losses. As of March 31, 2008, included in the allowance for loan losses is $25 million for credit losses for this pool.
The carrying amount of those loans included in loans held for investment are as follows (in millions):
|
March 31, 2008 |
December 31, 2007 |
|||||
---|---|---|---|---|---|---|---|
Contractual UPB | $ | 2,852 | $ | 3,052 | |||
Discount | (327 | ) | (398 | ) | |||
Carrying amount | 2,525 | 2,654 | |||||
Allowance for loan losses | (25 | ) | — | ||||
Carrying amount, net of allowance | $ | 2,500 | $ | 2,654 | |||
The following summarizes the activity in this pool (in millions):
|
March 31, 2008 |
December 31, 2007 |
|||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Discount |
Net Book Value |
Discount |
Net Book Value |
|||||||||
Balance, beginning of period | $ | (398 | ) | $ | 2,654 | $ | (429 | ) | $ | 2,741 | |||
Realized losses(1) | 76 | (84 | ) | 19 | (50 | ) | |||||||
Cash collections and prepayments | — | (40 | ) | — | (59 | ) | |||||||
Yield income recognition(2) | (5 | ) | (5 | ) | 12 | 22 | |||||||
Balance, end of period | $ | (327 | ) | $ | 2,525 | $ | (398 | ) | $ | 2,654 | |||
38
As the housing and mortgage markets deteriorated during 2007, we made adjustments to key assumptions used to establish our loss reserves. Generally, we adjusted our assumptions as to frequency of mortgage loans moving to default and the expected severities of losses from sales of underlying REO properties. We also adjusted assumptions on our builder construction portfolio to give consideration to the project and market specific condition for loans in this portfolio that have or are expected to default.
The following summarizes our loans HFI portfolio by division and the corresponding allowance for loan losses as of March 31, 2008 (dollars in millions):
By Division |
Recorded Value |
Allowance for Loan Losses |
Total Reserves as a Percentage of Book Value |
|||||||
---|---|---|---|---|---|---|---|---|---|---|
SFR mortgage loans HFI | $ | 11,937 | $ | 194 | 1.63 | % | ||||
Consumer construction | 2,196 | 30 | 1.36 | % | ||||||
Warehouse lending | 12 | — | — | % | ||||||
Total on-going businesses | 14,145 | 224 | 1.58 | % | ||||||
Homebuilder | 1,056 | 204 | 19.30 | % | ||||||
Home equity | 1,498 | 49 | 3.28 | % | ||||||
Other | 27 | 6 | 19.99 | % | ||||||
Total discontinued business activities | 2,581 | 259 | 10.01 | % | ||||||
Total HFI portfolio at March 31, 2008 | $ | 16,726 | $ | 483 | 2.89 | % | ||||
Total HFI portfolio at December 31, 2007 | $ | 16,454 | $ | 398 | 2.42 | % | ||||
For the homebuilder division, the allowance for loan losses as of March 31, 2008 increased to $204 million, or 19.3% of the outstanding balance of its portfolio, from $199 million at December 31, 2007. We are monitoring this portfolio very closely due to rapidly changing conditions affecting both the underlying collateral values and the projected repayment sources in the current environment. The allowance for loan losses increased on the SFR mortgage loans HFI division, homebuilder division, and home equity division portfolios. This increase in the allowance for loan losses, as well as higher realized delinquency rates and other current environmental factors, have resulted in our projecting higher future losses than were previously expected.
39
Summarized below are changes to the allowance for loan losses for the periods indicated (dollars in millions):
|
Three Months Ended |
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
March 31 |
|
|||||||||
|
December 31, 2007 |
||||||||||
|
2008 |
2007 |
|||||||||
Balance, beginning of period | $ | 398 | $ | 62 | $ | 162 | |||||
Allowance transferred to loans HFS | (1 | ) | (2 | ) | (6 | ) | |||||
Provision for loan losses | 132 | 11 | 269 | ||||||||
Charge-offs: | |||||||||||
SFR mortgage loans HFI division | (14 | ) | (2 | ) | (16 | ) | |||||
Consumer construction division | (23 | ) | (1 | ) | (12 | ) | |||||
Other(1) | (11 | ) | (2 | ) | (1 | ) | |||||
Total charge-offs | (48 | ) | (5 | ) | (29 | ) | |||||
Recoveries: | |||||||||||
SFR mortgage loans HFI division | 1 | 1 | 1 | ||||||||
Consumer construction division | — | — | — | ||||||||
Other(1) | 1 | 1 | 1 | ||||||||
Total recoveries | 2 | 2 | 2 | ||||||||
Total charge-offs, net of recoveries | (46 | ) | (3 | ) | (27 | ) | |||||
Balance, end of period | $ | 483 | $ | 68 | $ | 398 | |||||
Annualized charge-offs to average loans HFI | 1.14 | % | 0.15 | % | 0.84 | % |
In the first quarter of 2008, net charge-offs increased to $46 million from $3 million in the first quarter of 2007, primarily in the SFR mortgage loans HFI division and the consumer construction division portfolios. This is consistent with the overall conditions in both the mortgage and the housing markets that contributed to the overall increase in delinquencies and loans migrating through the foreclosure process.
The charge-off policy for the SFR first lien mortgage loans was revised as of January 1, 2008. Previously, loan losses were charged-off against the allowance for loan loss when available information confirmed that specific loans or portions thereof were uncollectible. The charge-off was based on our estimate of value of the collateral securing the loan. This initial assessment of whether a charge-off was required was made no later than the 180th day of delinquency. Under the revised policy, the Company evaluates these SFR first lien mortgage loans for impairment under SFAS 114 when these loans are 180 days past due. The allowance for loans identified as impaired is based on an estimate of recoverability and value of the collateral securing the loans. This impairment valuation allowance is established with reference to the difference between the loan's carrying value and the estimated fair value of the collateral securing the loan reduced by the cost to sell the collateral. As of March 31, 2008, the specific valuation allowance related to the 180 days past due SFR first lien mortgage loans was $33 million.
While we consider the allowance for loan losses to be adequate based on information currently available, future adjustments to the allowance may be necessary due to changes in economic conditions, further declines in real estate values, delinquency levels, foreclosure rates, or loss rates. The level of allowance for loan losses is also subject to review by the OTS. The OTS may require the allowance for loan losses to be increased based on its evaluation of the information available to it at the time of its examination of the Bank.
With respect to mortgage loans HFS, pursuant to the applicable accounting rules, we do not provide an allowance for loan losses. Instead, a component for credit risk related to loans HFS (excluding those
40
loans where we elected fair value) is embedded in the market valuation for these loans. Given the changes in our production volume and quality, we expect this amount to be significantly less this year than in 2007.
The following summarizes our HFS portfolio, the corresponding market valuation reserves and non-performing assets as of the dates indicated (dollars in millions):
|
March 31 |
|
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
December 31, 2007 |
||||||||||
|
2008 |
2007 |
|||||||||
Loans HFS before market valuation reserves (excluding HFS loans at fair value) | $ | 923 | $ | 10,579 | $ | 3,778 | |||||
Market valuation reserves(1) | 9 | (65 | ) | (3 | ) | ||||||
Net loans HFS portfolio | $ | 914 | $ | 10,514 | $ | 3,775 | |||||
Market valuation reserves as a % of gross loans HFS | 1.00 | % | 0.62 | % | 0.09 | % | |||||
Non-performing loans HFS before market valuation reserves | $ | — | $ | 174 | $ | 8 | |||||
Market valuation reserves | — | (37 | ) | (2 | ) | ||||||
Net non-performing loans HFS | $ | — | $ | 137 | $ | 6 | |||||
Non-performing loans held for sale as a % of net loans HFS portfolio | — | % | 1.30 | % | 0.15 | % | |||||
We adopted SFAS 159 effective January 1, 2008 and elected the fair value option for certain existing and new loans held for sale, including reverse mortgage loans. As a result of this adoption, loans held for sale recorded at fair value as of March 31, 2008 were $2.4 billion. For further information on SFAS 159, refer to "Notes to Consolidated Financial Statements—Note 5, Fair Value of Financial Instruments".
We do not generally sell loans with recourse. However, we can be required to repurchase loans from investors when our loan sales contain individual loans that do not conform to the representations and warranties we made at the time of sale (including early payment default provisions). We maintain a secondary market reserve for losses that arise in connection with loans that we may be required to repurchase from whole loan sales, sales to the GSEs, and securitizations. The reserve has two general components: reserves for repurchases arising from representation and warranty claims and reserves for repurchases arising from early payment defaults.
41
The following reflects our loan sale and repurchase activities for the periods indicated (dollars in millions):
|
Three Months Ended |
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
March 31 |
|
|||||||||
|
December 31, 2007 |
||||||||||
|
2008 |
2007 |
|||||||||
Loans sold: | |||||||||||
GSEs and whole loans | $ | 9,862 | $ | 17,146 | $ | 10,033 | |||||
Securitization trusts | 58 | 7,391 | 3,392 | ||||||||
Total | $ | 9,920 | $ | 24,537 | $ | 13,425 | |||||
Total repurchases | $ | 29 | $ | 224 | $ | 51 | |||||
Repurchases as a percentage of total loans sold during the period | 0.35 | % | 0.91 | % | 0.38 | % |
The following reflects the activity in the secondary market reserve during the periods indicated (in millions):
|
Three Months Ended |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
March 31 |
|
||||||||
|
December 31, 2007 |
|||||||||
|
2008 |
2007 |
||||||||
Balance, beginning of period | $ | 180 | $ | 34 | $ | 57 | ||||
Additions/provisions | 24 | 32 | 145 | |||||||
Charges for losses on repurchased loans | (16 | ) | (15 | ) | (22 | ) | ||||
Balance, end of period | $ | 188 | $ | 51 | $ | 180 | ||||
Reserve levels are a function of expected losses based on actual pending and expected claims and repurchase requests, historical experience, loan volume and loan sales distribution channels and assessment of the probability of investor claims. Small changes in assumptions could result in a significantly higher or lower estimate. While the ultimate amount of repurchases and claims is uncertain, management believes the reserve is adequate. The provision for the secondary market reserve decreased to $24 million for the quarter ended March 31, 2008, from $145 million for the quarter ended December 31, 2007. This decline in the provision is due to a significantly smaller supplemental accrual for additional losses associated with loans sold prior to the first quarter of 2008. We had charges to the secondary market reserve of $16 million in the first quarter of 2008, mainly for mark-to-market adjustments on loans repurchased during the year, of which 80/20s accounted for over 80% of the adjustments. As previously noted, we no longer originate 80/20 loans1. We will continue to evaluate the adequacy of our reserve and allocate a portion of our gain/loss on sale proceeds to the reserve going forward although we cannot predict at this time the extent to which we will allocate such gain/loss on sale to the reserve. This secondary market reserve is included on the consolidated balance sheets as a component of "Other liabilities".
42
Credit Reserves Embedded in Non-Investment Grade and Residual Securities
As part of the securitization process, we create non-investment grade and residual securities which historically could be sold into the secondary market or retained on our balance sheet. These securities provide credit enhancement to absorb the losses in the securitization trust. Worsening loan performance has necessitated an increase in the amount of credit losses estimated in these securities.
The following shows more information on our non-investment grade and residual securities as of or for the periods indicated (dollars in millions):
|
As of or For the Three Months Ended |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
March 31 |
|
||||||||
|
December 31, 2007 |
|||||||||
|
2008 |
2007 |
||||||||
Non-investment Grade and Residual Securities: | ||||||||||
Fair market value | $ | 320 | $ | 271 | $ | 272 | ||||
As a percentage of tier 1 core capital | 18 | % | 13 | % | 14 | % | ||||