UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

Form 10-K

 

 

Commission file number: 1-8972

INDYMAC BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:

(800) 669-2300

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

[None.]

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. Yes o     No þ

 

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 þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K  þ.

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ     Accelerated filer o     Non-accelerated filer 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 þ

 

Based on the closing price for shares of Common Stock as of June 30, 2006, the aggregate market value of Common Stock held by non-affiliates of the registrant was approximately $3,119,794,294. For the purposes of the foregoing calculation only, in addition to affiliated companies, all directors and executive officers of the registrant have been deemed affiliates.

 

As of February 16, 2007, 72,329,748 shares of IndyMac Bancorp, Inc. Common Stock, $.01 par value per share, were outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

Proxy Statement for the 2007 Annual Meeting — Part III

 

 

INDYMAC BANCORP, INC.

 

2006 ANNUAL REPORT ON FORM 10-K

 

TABLE OF CONTENTS

 

INDYMAC BANCORP, INC.

 

2006 ANNUAL REPORT ON FORM 10-K

 

TABLE OF CONTENTS

 

Items 1. and 7.

 

 

FORWARD-LOOKING STATEMENTS

 

Certain statements contained in this Form 10-K may be deemed to be forward-looking statements within the meaning of the federal securities laws. The words “anticipate,” “believe,” “estimate,” “expect,” “project,” “plan,” “forecast,” “intend,” “goal,” “target,” and similar expressions 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 industry volumes and margins; the level and volatility of interest rates; the Company’s hedging strategies, hedge effectiveness and asset and liability management; the accuracy of subjective estimates used in determining the fair value of financial assets of Indymac; the credit risks with respect to our loans and other financial assets; the actions undertaken by both current and potential new competitors; the availability of funds from Indymac’s lenders and from loan sales and securitizations to fund mortgage loan originations and portfolio investments; the execution of Indymac’s growth plans and ability to gain market share in a significant market transition; the impact of disruptions triggered by natural disasters; the impact of current, pending or future legislation, regulations or litigation; and other risk factors described in the reports that Indymac files with the Securities and Exchange Commission, including this Annual Report on Form 10-K, its Quarterly Reports on Form 10-Q, and its reports on Form 8-K.

 

While all of the above items are important, the highlighted items represent those that, in management’s view, merit increased focus given current conditions.

 

IndyMac Bancorp, Inc. is the holding company for IndyMac Bank, F.S.B., a $29 billion hybrid thrift/mortgage bank, headquartered in Pasadena, California (“Indymac Bank” or “Bank”). Indymac Bank originates mortgages in all 50 states of the U.S. and is the largest savings and loan headquartered in Los Angeles County, California, the seventh largest nationwide, based on assets according to American Banker, the ninth largest residential mortgage originator according to the National Mortgage News based on third quarter 2006 mortgage origination volume, and the eleventh largest mortgage servicer according to National Mortgage News as of September 30, 2006. Indymac Bank, operating as a hybrid thrift/mortgage banker, provides cost-efficient financing for the acquisition, development, and improvement of single-family homes. Indymac also provides financing secured by single-family homes and other banking products to facilitate consumers’ personal financial goals. We facilitate the acquisition, development, and improvement of single-family homes through our e-MITS(R) (Electronic Mortgage Information and Transaction System) platform that automates underwriting, risk-based pricing and rate locking on a nationwide basis via the Internet at the point of sale. Indymac Bank offers highly competitive mortgage products and services that are tailored to meet the needs of both consumers and mortgage professionals.

 

Indymac (then known as Countrywide Mortgage Investments, Inc.) was founded as a passive mortgage real estate investment trust (“REIT”) in 1985 and transitioned its business model to become an active, operating mortgage lender in 1993. In response to the global liquidity crisis in the fourth quarter of 1998 in which many non-regulated financial institutions, mortgage lenders and mortgage REITs were adversely impacted or did not survive, we determined that it would be advantageous to become a depository institution. The depository structure provides significant advantages in the form of diversified financing sources, the retention of capital to support growth, and a strong platform for the origination of mortgages. Effective January 1, 2000, we terminated our status as a REIT and converted to a fully taxable entity, and, on July 1, 2000, we acquired SGV Bancorp, Inc. (“SGVB”), which then was the parent of First Federal Savings and Loan Association of San Gabriel Valley, a federal savings association. We contributed substantially all of our assets and operations to the subsidiary savings association, which we renamed Indymac Bank.

 

We entered the reverse mortgage industry through the acquisition of 93.75% of the outstanding shares of common stock of Financial Freedom Holdings, Inc. (“Financial Freedom”), the leading provider of reverse mortgages in the United States of America, and the related assets from Lehman Brothers Bank, F.S.B. and its affiliates on July 16, 2004. The remaining shares of the common stock of Financial Freedom, constituting 6.25% of the outstanding shares of common stock, were held by its chief executive officer, James Mahoney, after the

acquisition. The acquisition was consummated as part of our strategy to increase market share by offering niche mortgage products and servicing a broad customer base. On July 3, 2006, the Company purchased from James Mahoney the remaining 6.25% interest in Financial Freedom for $40 million. Financial Freedom now operates as a wholly-owned subsidiary of Indymac Bank.

 

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.

 

BUSINESS MODEL

 

Indymac’s hybrid thrift/mortgage banking business model is the basis for our corporate structure. Our model provides a strong framework for growth over the long-term and the flexibility to operate efficiently in varying interest-rate environments. Our businesses are aligned into two primary operating segments, the mortgage banking and the thrift segments. Mortgage banking involves the originating and trading of mortgage loans and related assets, and the servicing of these loans. The revenues from mortgage banking consist primarily of gains on sale of the loans; interest income earned while the loans are held for sale; and the servicing fees. The thrift side of our business invests in single-family residential mortgage assets including mortgage-backed securities (“MBSs”) which we hold on our balance sheet. Revenues consist primarily of spread income, which represents the difference between the interest earned on the loans and the cost of funds.

 

As a result of the quick asset turn times associated with mortgage banking, it is less capital-intensive than thrift investing and offers higher returns on invested capital. However, mortgage banking is cyclical: origination volumes are closely correlated to interest rates, rising when rates fall and falling when rates rise.

 

Thrift investing requires more capital than mortgage banking, resulting in lower returns on invested capital. However, the returns tend to be more stable and less cyclical than those from mortgage banking, and they generally improve as returns on mortgage banking decline. As interest rates rise, there is little incentive for borrowers to refinance, so portfolio runoff (i.e., reduction) is reduced.

 

Our hybrid business model allows us to take advantage of both the higher returns on invested equity offered by mortgage banking, and the earnings stability offered by a traditional savings and loan institution. The common denominator of the Company’s business is providing consumers with single-family residential mortgages through relationships with each segment’s core customers via the channels in which we operate. Prudent allocation of capital between our mortgage banking and thrift segments, depending on the interest rate environment, market conditions and expected return on equity, serves to stabilize earnings through the mortgage cycles. With our hybrid model, we can take advantage of opportunities to fund and sell loans, but we also prudently build a portfolio of high-quality investment loans and mortgage-backed securities, as well as a substantial servicing portfolio to provide more consistent income throughout the interest rate cycle. By deploying capital in the area that offers the best returns, we are able to stabilize earnings through a variety of economic and interest rate cycles.

 

Indymac’s long-term strategy focuses on gaining a larger share of the mortgage origination market without compromising profitability goals. During 2006, we successfully executed our strategy and reached a record level of mortgage production of $90.0 billion and increased our market share by 78% to 3.58% while the market volume declined. According to the National Mortgage News, by the third quarter of 2006, we were the ninth largest originator of mortgage loans in the United States of America. We will continue to leverage our mortgage-banking infrastructure, increase our marketing and sales efforts, and expand our geographic presence in an effort to gain additional market share in the future.

 

In the fourth quarter of 2006, we saw a fairly dramatic decrease in the return on equity (“ROE”) in our thrift segment, mostly caused by net interest margin erosion in our whole loan and MBS portfolios. As such, it does not make economic sense for us to grow these portfolios to the extent that we had previously planned. While we will continue to maintain some level of investments in our whole loan and MBS portfolios, going forward the growth of these portfolios will be based on the extent to which (1) their ROEs exceed our cost of both core and risk-based capital or (2) they are needed to support our core mortgage banking investments in mortgage servicing rights and residual and non-investment grade securities, if their ROEs are below our cost of capital. These changes in our business model and strategy represent fine-tuning more than a major strategic shift.

SEGMENTS

 

Indymac is structured to achieve synergies among its operations and to enhance customer service, operating through its two main segments, the mortgage banking and the thrift segments. The common denominator of the Company’s business is providing consumers with single-family residential mortgages through relationships with each segment’s core customers via the channel in which each operates.

 

For further information on the revenues earned and expenses incurred by each of our segments, refer to “Note 3 — Segment Reporting” included in the Company’s consolidated financial statements incorporated herein.

 

MORTGAGE BANKING

 

The mortgage banking segment’s core activities are loan production, loan sales, and the performance of our servicing functions. Loan production is achieved by delivering a suite of mortgage products, predominantly prime credit quality, to our customers using a technology-based approach across multiple channels on a nationwide basis supported by 16 strategically distributed regional mortgage centers. Our broad product line includes adjustable-rate mortgages (“ARMs”), intermediate term fixed-rate loans, pay option ARMs offering borrowers multiple payment options, fixed-rate mortgages, both conforming and non-conforming, construction-to-permanent loans, subprime mortgages, home equity lines of credits (“HELOCs”) and reverse mortgages.

 

Our largest production channel, mortgage professionals group, originates or purchases mortgage loans through its relationships with mortgage brokers, mortgage bankers, and financial institutions. We also offer mortgages and reverse mortgages to consumers through channels such as direct mail, Internet leads, online advertising, affinity relationships, real estate professionals, including realtors, and through our Southern California retail banking branches.

 

When we have accumulated a sufficient volume of loans with similar characteristics, generally $100 million to $1.5 billion in principal amount, we sell the loans in the secondary market. The length of time between when we originate or purchase a mortgage loan and when we sell or securitize the mortgage loan generally ranges from 10 to 90 days, depending on factors such as loan volume by product type and market fluctuations in the prices of MBS. On average during 2006, we sold loans within 50 days of purchase or origination, down from 52 days in 2005.

 

We sell the majority of the mortgage loans that we originate or purchase (88% in 2006). The loans are usually sold on a non-recourse basis, but we do make certain representations and warranties concerning the loans. We generally retain the servicing rights with respect to loans sold to the government sponsored enterprises (“GSEs”), primarily Federal National Mortgage Association (“Fannie Mae”) and Federal Home Loan Mortgage Company (“Freddie Mac”). The credit losses on these loans are absorbed by the GSEs. We pay guarantee fees to the GSEs to compensate them for their assumption of credit risk.

 

We also sell loans through private-label securitizations. Loans sold through private-label securitizations consist primarily of non-conforming loans and subprime loans. The securitization process involves the sale of the loans to one of our wholly-owned bankruptcy remote special purpose entities, which then sells the loans to a separate, transaction-specific securitization trust in exchange for cash and certain trust interests that we retain. The securitization trust issues and sells undivided interests to third-party investors that entitle the investors to specified cash flows generated from the securitized loans. These undivided interests are usually represented by certificates with varying interest rates and are secured by the payments on the loans acquired by the trust, and commonly include senior and subordinated classes. The senior class securities are usually rated “AAA” by at least two of the major independent rating agencies and have priority over the subordinated classes in the receipt of payments. We have no obligation to provide funding support (other than temporary servicing advances) to either the third-party investors or securitization trusts. Neither the third-party investors nor the securitization trusts have recourse to our assets or us, and neither have the ability to require us to repurchase their securities. We do make certain representations and warranties concerning the loans, such as lien status or mortgage insurance coverage, and if we are found to have breached a representation or warranty, we could be required to repurchase the loan from the securitization trust. We do not guarantee any securities issued by the securitization trusts. The securitization trusts represent “qualified special purpose entities,” which meet the legal isolation criteria of Statement of Financial Accounting Standards No. 140, “Accounting for Transfer and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS 140”), and are therefore not consolidated for financial reporting purposes. We also sell loans on

a whole-loan basis to institutional investors with servicing on such loans either retained by us or released to the institutional investors.

 

In addition to the cash we receive from the sale of MBS, we typically retain certain interests in the securitization trust as payment for the loans. These retained interests may include mortgage servicing rights (“MSRs”), AAA-rated interest-only securities, AAA-rated senior securities, AAA-rated principal-only securities, subordinated classes of securities, residual securities, securities associated with prepayment charges on the underlying mortgage loans, cash reserve funds, or an overcollateralization account. Other than AAA-rated interest-only and principal-only securities, the AAA-rated senior securities, the securities associated with prepayment charges on the underlying mortgage loans, and the MSRs, these retained interests are subordinated and serve as credit enhancement for the more senior securities issued by the securitization trust. We are entitled to receive payment on most of these retained interests only after the third party investors are repaid their investment plus interest and there is excess cash in the securitization trust. Our ability to obtain repayment of our residual interests depends solely on the performance of the underlying mortgage loans. Material adverse changes in performance of the loans, including actual credit losses and prepayment speeds differing from our assumptions, may have a significant adverse effect on the value of these retained interests.

 

We usually retain the servicing rights for the securitized mortgage loans, as discussed in the description of servicing operations below under the caption “Loan Servicing.” As a servicer, we are entitled to receive a servicing fee equal to a specified percentage of the outstanding principal balance of each loan. This servicing fee is calculated and payable on a monthly basis. We may also be entitled to receive additional servicing compensation, such as late payment fees or prepayment charges. Our servicing fees have priority in payment over each class of securities issued by the securitization trusts.

 

Refer to “Note 14 — Transfers and Servicing of Financial Assets” in the accompanying notes to consolidated financial statements for additional information.

 

Production Divisions

 

Mortgage Professionals Group

 

Our largest production channel, mortgage professionals group, was responsible for 86% of our total mortgage production during 2006. This group is responsible for the production of mortgage loans through relationships with mortgage brokers, mortgage bankers, financial institutions, capital market participants across the country, and homebuilders via three channels: wholesale, correspondent, and conduit. Mortgage loans could be either funded by us (wholesale) or obtained as closed loans on a flow basis (correspondent) or in bulk purchases (conduit). When originating or purchasing mortgage loans, we generally acquire the rights to “service” the mortgage loans (as described below). When we sell the loans, we may either retain the related servicing rights and service the loans through our Home Loan Servicing division or sell those rights. See “Loan Servicing” below.

 

This division targets customers based on their loan production volume, product mix and projected revenue to us. The sales force is responsible for maintaining and increasing loan production from these customers by marketing our strengths, which include a “one stop shop” for all products, competitive pricing and response time efficiencies in the loan purchase process through our e-MITS underwriting process and high customer service standards.

 

During 2006, to continue our emphasis on increasing production capacity and geographic penetration to build market share, the division opened three new regional centers. With these three new centers, the division currently has 16 regional centers. Looking ahead, we plan to add several new regional offices in the coming years as a way of increasing geographic penetration to gain market share in target markets, improving customer service, and improving operational efficiencies.

 

The retail lending group, a division of the mortgage professionals group, will open storefront mortgage offices in areas supported by regional operating centers. These offices will offer mortgage services through the retail channel, anchored by a proven local producing leader. The choice of areas in which to open retail mortgage offices will be determined based upon several factors, such as the availability of local talent and the demographic characteristics of the area. We plan to open 15 to 20 retail mortgage offices in 2007.

 

In February 2007, the Company entered into a definitive agreement to purchase assets of the retail mortgage banking platform of New York Mortgage Company, LLC (“NYMC”), a wholly owned taxable REIT subsidiary of

New York Mortgage Trust, Inc. As part of the transaction, the Company will hire a majority of NYMC’s employees, including approximately 200 retail loan officers and a strong retail branch management team. This acquisition is part of our strategy to build our retail platform. See “Note 27 — Subsequent Events” in the accompanying notes to consolidated financial statements for further discussion on the acquisition.

 

Consumer Direct

 

This channel markets mortgage products directly to existing and new consumers nationwide through direct mail, Internet lead aggregator, outbound telesales, online advertising, and referral programs, as well as our Southern California retail banking branches.

 

Through our call center operations and our Southern California retail banking branch network, loan consultants counsel consumers on the loan application process and make lending decisions using our e-MITS technology. Loans are processed and funded by our operations group within our regional call centers.

 

Financial Freedom

 

Through the acquisition of Financial Freedom, we have become the leading provider of reverse mortgages in the United States. This group is responsible for the generation and servicing of predominantly reverse mortgage products with senior customers via the affinity business unit to institutional relationships, traditional wholesale mortgage relationship sales force and a retail loan officer sales force. Reverse mortgages allow homeowners age 62 and older to convert home equity into cash to supplement their retirement income. The equity may be withdrawn in a lump sum, as annuity-style monthly payments, as a credit line, or any combination thereof. Reverse mortgages offered by us feature: no recourse to the borrower, no repayment during the borrower’s occupancy of the home, and a repayment amount that cannot exceed the value of the home (after costs of sale). With the increased familiarity that senior homeowners and their financial advisors have with this product, the reverse mortgage market is expected to continue to grow. Comparing 2006 to 2005, our reverse mortgage volume increased 71% to $5.0 billion in 2006 from $2.9 billion in 2005. However, the competition is expected to intensify in this market. As a result, margin for this product will be negatively impacted.

 

Loan Servicing

 

MSRs and Other Retained Assets

 

This division manages the assets the Company retains in conjunction with its mortgage loan sales. The assets held include the following asset classes: (i) mortgage servicing rights (“MSRs”), interest-only strips, prepayment penalty securities and residual securities; (ii) derivatives and securities held as hedges of such assets, including forward rate agreements swaps, options, futures, principal-only securities, agency debentures and U.S. Treasury bonds; (iii) loans acquired through clean-up calls or originated through the Company’s customer retention programs; and (iv) investment and non-investment grade securities. The Company hedges the MSRs to protect the economic value of the MSRs.

 

At December 31, 2006, primarily through our Home Loan Servicing operation in Kalamazoo, Michigan, we serviced $148.0 billion of mortgage loans, of which $139.8 billion was serviced for others, an increase of 65% from $84.5 billion serviced for others in 2005. The growth in our portfolio of loans serviced for others was attributable to our record production and sale volumes in 2006. The servicing portfolio includes servicing for prime and subprime loans, HELOCs, reverse mortgages, manufactured housing loans and home improvement loans.

 

Servicing of mortgage loans includes: collecting loan payments; responding to customers’ inquiries; accounting for principal and interest; holding custodial (impound) funds for payment of property taxes and insurance; counseling delinquent mortgagors; modifying and refinancing loans; supervising foreclosures and liquidation of foreclosed property; performing required tax reporting; and performing other loan administration functions necessary to protect investors’ interests and comply with applicable laws and regulations. Servicing operations also include remitting loan payments, less servicing fees, to trustees and, in some cases, advancing delinquent borrower payments to investors, subject to a right of reimbursement.

 

THRIFT

 

The strategy of our thrift segment has been to leverage and scale infrastructure with prudent mortgage related asset growth to stabilize and diversify company-wide earnings, targeting a return on equity ranging from 15% to 20%. Through leveraging our capital and our FDIC-insured financial institution, the thrift segment principally invests in single-family residential (“SFR”) mortgage loans (predominantly prime ARMs, including intermediate term fixed-rate loans), construction financing for single-family residences or lots provided directly to individual consumers, builder construction financing facilities for larger residential subdivision loans, HELOCs, mortgage-backed securities, and warehouse lines of credit, which provides short- term revolving warehouse lending facilities to small-to-medium size mortgage bankers and brokers to finance mortgage loans from the closing of the loans until they are sold. The thrift segment also occasionally engages in loan sales with servicing retained, principally of HELOCs and lot loans, as part of our balance sheet management efforts and our efforts to optimize returns on equity. The primary sources of revenue for the thrift segment are net interest income on loans and securities, and to a lesser extent, the gain on sale of HELOCs and lot loans.

 

In the fourth quarter of 2006, we saw a fairly dramatic decrease in the ROE in our thrift segment, mostly caused by net interest margin erosion in our whole loan and MBS portfolios. As such, it does not make economic sense for us to grow these portfolios to the extent that we had previously planned. While we will continue to maintain some level of investments in our whole loan and MBS portfolios, going forward the growth of these portfolios will be based on the extent to which (1) their ROEs exceed our cost of both core and risk-based capital or (2) they are needed to support our core mortgage banking investments in mortgage servicing rights and residual and non-investment grade securities, if their ROEs are below our cost of capital. These changes in our business model and strategy represent fine-tuning more than a major strategic shift. The new reality of narrowing net interest margins actually favors Indymac from a competitive standpoint in that, unlike many other depository institutions, we already have a relatively high, market-based cost of funds and have learned, through trading assets and loans in the secondary market, how to earn strong overall ROEs despite that fact.

 

Portfolio Divisions

 

Mortgage Backed Securities (“MBS”)

 

MBS includes predominantly AAA-rated agency and private label MBS.

 

Prime SFR Mortgage Loans

 

Single-family residential mortgage loans held for investment are generally originated or acquired through our mortgage banking production divisions and transferred to the thrift divisions. Held for investment loans may also be acquired from third party sellers. Such loans are typically prime loans as the majority of the subprime loans originated are securitized in private transactions or sold to GSEs. The thrift divisions invest in loans for which they can earn an acceptable return on equity. We are currently investing primarily in ARMs in order to minimize interest rate risk, and to a lesser extent, loan products which we believe the market does not properly price. We may also retain a portion of the loans acquired through our exercise of clean-up calls as these loans are generally high quality, seasoned loans that generate an above-market yield.

 

Home Equity Division

 

Our home equity division specializes in providing HELOC and closed-end second mortgages nationwide through Indymac’s wholesale and retail channels. With a state-of-the-art web-based decision engine, utilizing a streamlined application process and competitive pricing, this division provides homeowners the ability to easily tap the excess equity in their homes for a variety of uses. With the HELOC product, homeowners have convenient access to their funds using the Indymac Visa Equity Card or equity checks.

 

Consumer Construction and Lot Loans

 

Our consumer construction and lot loans division provides construction financing for individual consumers who want to build a new primary residence or second home. Through our streamlined e-MITS online application process, the division offers a single-close construction-to-permanent loan that provides borrowers with the funds to build a primary residence or vacation home. This product typically provides financing for a construction term of 6 to 12 months and automatically converts to a permanent mortgage loan at the end of construction. The end result is a

product that represents a hybrid activity between our portfolio lending and mortgage banking activities. The Company earns net interest income on these loans during the construction phase. When the home is completed, the loan automatically converts to a permanent mortgage loan without any additional cost or closing documents, which is typically sold in the secondary market or acquired by the SFR mortgage loan portfolio. This division also provides financing to builders who are building single-family residences without a guaranteed sale at inception of project, or on a speculative basis. Approximately 68% of new commitments are generated through mortgage broker customers of the Mortgage Bank and the remaining 32% of new commitments are retail originations.

 

Builder Financing

 

Our homebuilder division provides land acquisition, development and construction financing to homebuilders for residential construction. Builder construction loans are typically adjustable-rate loans, indexed to the prime interest rate with terms ranging from 12 to 24 months. The Company earns net interest income on these loans. The homebuilder division has central operations in Pasadena, California with 17 satellite sales offices in Arizona, California, Colorado, Florida, Illinois, Massachusetts, North Carolina, Oregon, Tennessee, Texas, and Washington, D.C. Our typical customer is a middle size, professional homebuilder who builds between 200 and 2,000 homes per year. We do a limited amount of business with large private and public homebuilders, and have a small homebuilder program dedicated to homebuilders building five to 25 unit projects, and who typically build five to 100 homes per year.

 

Warehouse Lending

 

Our warehouse lending group offers short-term lines of credit to approved correspondent sellers nationwide. The group functions as a financial intermediary for lenders, providing them with the financial capacity to fund loans and hold them on the balance sheet until they are sold to approved investors.

 

REGULATION AND SUPERVISION

 

GENERAL

 

As a savings and loan holding company, Indymac Bancorp is subject to regulation by the Office of Thrift Supervision (“OTS”) under the savings and loan holding company provisions of the Federal Home Owners’ Loan Act (“HOLA”). As a federally chartered and insured savings and loan association, Indymac Bank is subject to regulation, supervision and periodic examination by the OTS, which is the primary federal regulator of savings associations, and the Federal Deposit Insurance Corporation (“FDIC”), in its role as federal deposit insurer. The primary purpose of regulatory examination and supervision is to protect depositors, financial institutions and the financial system as a whole rather than the shareholders of financial institutions or their holding companies. The following summary is not intended to be a complete description of the applicable laws and regulations or their effects on us, and it is qualified in its entirety by reference to the particular statutory and regulatory provisions described.

 

REGULATION OF INDYMAC BANK

 

General

 

Both Indymac Bank and the Company are required to file periodic reports with the OTS concerning our activities and financial condition. The OTS has substantial enforcement authority with respect to savings associations, including authority to bring enforcement actions against a savings association and any of its “institution-affiliated parties,” which term includes directors, officers, employees, controlling shareholders, agents and other persons who participate in the conduct of the affairs of the institution. The FDIC has “backup” enforcement authority over us and has the power to terminate a savings association’s FDIC deposit insurance. In addition, we are subject to regulations of the Federal Reserve Board relating to equal credit opportunity, electronic fund transfers, collection of checks, truth in lending, truth in savings, and availability of funds for deposit customers.

 

Qualified Thrift Lender Test

 

Like all savings and loan holding company subsidiaries, Indymac Bank is required to meet a qualified thrift lender (“QTL”) test to avoid certain restrictions on our operations, including the activities restrictions applicable to

multiple savings and loan holding companies, restrictions on our ability to branch interstate and Indymac Bancorp’s mandatory registration as a bank holding company under the Bank Holding Company Act of 1956. A savings association satisfies the QTL test if: (i) on a monthly average basis, for at least nine months out of each twelve month period, at least 65% of a specified asset base of the savings association consists of loans to small businesses, credit card loans, educational loans, or certain assets related to domestic residential real estate, including residential mortgage loans and mortgage securities; or (ii) at least 60% of the savings association’s total assets consist of cash, U.S. government or government agency debt or equity securities, fixed assets, or loans secured by deposits, real property used for residential, educational, church, welfare, or health purposes, or real property in certain urban renewal areas. Indymac Bank is currently, and expects to remain, in compliance with QTL standards.

 

Regulatory Capital Requirements

 

OTS capital regulations require savings associations to satisfy three sets of capital requirements: tangible capital, Tier 1 (leverage) capital, and risk-based capital. In general, an association’s tangible capital, which must be at least 1.5% of adjusted total assets, is the sum of common shareholders’ equity adjusted for the effects of other comprehensive income (“OCI”), less goodwill and other disallowed assets. An association’s ratio of Tier 1 capital to adjusted total assets (the “core capital” or “leverage” ratio) must be at least 3% for strong associations that are not anticipating or experiencing significant growth and have well-diversified risks, including no undue interest rate risk exposure, excellent asset quality, high liquidity, and good earnings, and 4% for others. Higher capital ratios may be required if warranted by the particular circumstances, risk profile, or growth rate of a given association. Under the risk-based capital requirement, a savings association must have Tier 1 (core) capital equal to at least 4% of adjusted total assets and total capital (core capital plus supplementary capital) equal to at least 8% of risk-weighted assets. Tier 1 capital must represent at least 50% of total capital and consists of core capital elements, which include common shareholders’ equity, qualifying noncumulative, nonredeemable perpetual preferred stock, and minority interests in the equity accounts of consolidated subsidiaries, but exclude goodwill and certain other intangible assets. Supplementary capital mainly consists of qualifying subordinated debt, preferred stock that does not meet Tier 1 capital requirements, and portions of allowance for loan losses.

 

The above capital requirements are viewed as minimum standards by the OTS. The OTS regulations also specify minimum requirements for a savings association to be considered a “well-capitalized institution” as defined in the “prompt corrective action” regulation described below. A “well-capitalized” savings association must have a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater and a leverage ratio of 5% or greater. Indymac Bank currently meets, and expects to continue to meet, all of the requirements of a “well-capitalized institution.”

 

The OTS regulations include prompt corrective action provisions that require certain remedial actions and authorize certain other discretionary actions to be taken by the OTS against a savings association that falls within specified categories of capital deficiency. The relevant regulations establish five categories of capital classification for this purpose, ranging from “well-capitalized” or “adequately capitalized” through “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” In general, the prompt corrective action regulations prohibit an OTS-regulated institution from declaring any dividends, making any other capital distributions, or paying a management fee to a controlling person, such as its parent holding company, if, following the distribution or payment, the institution would be within any of the three undercapitalized categories.

 

Insurance of Deposit Accounts

 

Deposits of the Bank are presently insured by the Savings Association Insurance Fund (“SAIF”), which is administered by the FDIC, up to $100,000 per depositor. The FDIC has established a risk-based system for setting deposit insurance assessments. Under the risk-based assessment system, a savings association’s insurance assessments vary according to the level of capital the institution holds and the degree to which it is the subject of supervisory concern. Assessment rates currently range between five and 43 cents per $100 in deposits. Insurance of deposits may be terminated by the FDIC upon a finding that the savings association has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the OTS. All insured depository institutions, including the Bank, are required to pay an additional assessment, currently 1.22 cents per $100 in deposits, in order to retire Financial Corporation bonds that were issued between 1987 and 1989.

 

Capital Distribution Regulations

 

OTS regulations limit “capital distributions” by savings associations, which include, among other things, dividends and payments for stock repurchases. Refer to “Note 23 — Regulatory Requirements” in the accompanying notes to consolidated financial statements for further discussion.

 

Community Reinvestment Act and the Fair Lending Laws

 

Savings associations are examined under the Community Reinvestment Act (“CRA”) and related regulations of the OTS on the extent of their efforts to help meet the credit needs of their communities, including low and moderate-income neighborhoods. In addition, the Equal Credit Opportunity Act and the Fair Housing Act, together known as the “Fair Lending Laws,” prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. Enforcement of these regulations has been an important focus of federal regulatory authorities and of community groups in recent years. A failure by Indymac Bank to comply with the provisions of the CRA could, at a minimum, result in adverse action on branch and certain other corporate applications, and regulatory restrictions on our activities, and failure to comply with the Fair Lending Laws could result in enforcement actions by the OTS, as well as other federal regulatory agencies and the Department of Justice. Indymac Bank received an overall “Satisfactory” rating during our most recent CRA evaluation.

 

Privacy Protection

 

The OTS has adopted privacy protection regulations which require each savings association to adopt procedures to protect consumers’ and customers’ “nonpublic personal information.” It is Indymac Bank’s policy not to share customers’ information with any unaffiliated third parties, except as expressly permitted by law, or to allow third party companies to provide marketing services on our behalf, or under joint marketing agreements between us and other unaffiliated financial institutions. In addition to federal laws and regulations, we are required to comply with any privacy requirements prescribed by California and other states in which we do business that afford consumers with protections greater than those provided under federal law.

 

INCOME TAX CONSIDERATIONS

 

We report our income on a calendar year basis using the liability method of accounting. We are subject to federal income taxation under existing provisions of the Internal Revenue Code of 1986, as amended, in generally the same manner as other corporations. We are also subject to state taxes in the areas in which we conduct business.

 

EMPLOYEES

 

As of December 31, 2006, we had 8,630 full-time equivalent employees (“FTE”), including 633 FTE off-shore as part of our Global Resources program. We believe that we have generally good relations with our employees.

 

COMPETITION

 

We face significant competition in acquiring and selling loans. In our mortgage banking operations, we compete with other mortgage bankers, GSEs, established third party lending programs, investment banking firms, banks, savings and loan associations, and other lenders and entities purchasing mortgage assets. With regard to MBS issued through our mortgage banking operations, we face competition from other investment opportunities available to prospective investors. We estimate our market share of the U.S. mortgage market to be approximately 3.58% based on the full year 2006 mortgage production. A number of our competitors have significantly larger market share and financial resources. We seek to compete with financial institutions and mortgage companies through an emphasis on quality of service, diversified products and maximum use of technology.

 

The GSEs have made and we believe will continue to make significant technological and economic advances to broaden their customer bases. When the GSEs contract or expand, there are both positive and negative impacts on our mortgage banking lending operations. As GSEs expand, additional liquidity is brought to the market, and loan products can be resold more quickly. Conversely, expanding GSEs increase competition for loans, which may reduce profit margins on loan sales. We seek to address these competitive pressures by making a strong effort to maximize our use of technology, by diversifying into other residential mortgage products that are less affected by GSEs, and by operating in a more cost-effective manner than our competitors.

 

WEBSITE ACCESS TO UNITED STATES SECURITIES AND EXCHANGE COMMISSION
FILINGS

 

All reports filed electronically by us with the Securities and Exchange Commission (“SEC”), including Annual Reports on Form 10-K, quarterly reports on Form 10-Q, and current event reports on Form 8-K, as well as any amendments to those reports, are made accessible as soon as reasonably practicable after filing with the SEC at no cost on our website at www.IndymacBank.com. These filings are also accessible on the SEC’s website at www.sec.gov.

 

We have a Code of Business Conduct and Ethics that is applicable to all of our employees and officers, including the principal executive officer, the principal financial officer and the principal accounting officer. In addition, Indymac has a Director Code of Ethics that sets forth the policy and standards concerning ethical conduct for directors of Indymac. We also adopted formal corporate governance standards in January 2002, which the Corporate Governance Committee of the Board of Directors reviews annually to ensure they incorporate recent corporate governance developments and generally meet the corporate governance needs of Indymac. You may obtain copies of each of the Code of Business Conduct and Ethics, the Director Code of Ethics, and the Board of Directors’ Guidelines for Corporate Governance Issues by accessing the “Corporate Governance” subsection of the “Investors” section of www.IndymacBank.com, or free of charge by writing to our Corporate Secretary at IndyMac Bancorp, Inc., 888 East Walnut Street, Pasadena, California 91101. Indymac intends to post amendments to or waivers of the Code of Business Conduct and Ethics (to the extent applicable to Indymac’s principal executive officer, principal financial officer or principal accounting officer) and of the Director Code of Ethics at the website location referenced above.

 

KEY OPERATING RISKS

 

Like all businesses, we assume a certain amount of risk in order to earn returns on our capital. For further information on these and other key operating risks, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Risk Factors.”

 

None.

 

Our significant leased properties are as follows:

 

 

 

 

In addition to the above leased office space, we own the property (consisting of four buildings) that houses our mortgage banking headquarters, located in Pasadena, California, totaling approximately 265,000 square feet. We also own a building in La Mirada, California of approximately 16,500 square feet, which houses our information technology data center. We own an additional four retail banking properties, containing an aggregate of approximately 56,000 square feet, located in Southern California.

 

In the ordinary course of business, the Company and its subsidiaries are defendants in or parties to a number of legal actions. Certain of such actions involve alleged violations of employment laws, unfair trade practices, consumer protection laws, including claims relating to the Company’s sales, loan origination and collection efforts, and other federal and state banking laws. Management believes, based on current knowledge and after consultation with counsel, that these legal actions, individually and in the aggregate, and the losses, if any, resulting from the likely final outcome thereof, will not have a material adverse effect on the Company and its subsidiaries’ financial position, but may have a material impact on the results of operations of particular periods. Refer to “Note 21 — Commitments and Contingencies” in the accompanying notes to consolidated financial statements for further discussion.

 

No matters were submitted to a vote of shareholders during the quarter ended December 31, 2006.

 

STOCK INFORMATION

 

IndyMac Bancorp, Inc.’s common stock is traded on the New York Stock Exchange (“NYSE”) under the symbol “NDE.” The following table sets forth the high and low sales prices (as reported by Bloomberg Financial Service) for shares of IndyMac Bancorp, Inc.’s common stock for the years ended December 31, 2006 and 2005:

 

 

ISSUANCE OF COMMON STOCK

 

On June 8, 2004, we issued 3,200,000 shares of common stock at a market price of $31.75 through a public offering. On July 12, 2004, we issued an additional 130,000 shares of common stock at a market price of $31.75 upon the exercise of the underwriters’ over-allotment option. The cash proceeds of $96.25 million from the initial closing, net of expenses, were recorded as equity during the second quarter of 2004. The cash proceeds from the exercise of the over-allotment option, net of expenses, of $3.9 million were recorded as equity during the third quarter of 2004. Certain of the proceeds were used to finance the acquisition of Financial Freedom and the remaining proceeds have been used for general corporate purposes, including, but not limited to, continued asset growth for Indymac Bank.

 

The Company has a direct stock purchase plan which offers investors the ability to purchase shares of our common stock directly over the Internet. Investors interested in investing over $10,000 can also participate in the waiver program administered by Mellon Investor Services LLC. For the year ended December 31, 2006, we issued 3,532,360 shares of common stock at an average market price of $42.04 through this plan.

 

SHARE REPURCHASE ACTIVITIES

 

There was no share repurchase activity during the three months ended December 31, 2006. Our Board of Directors previously approved a $500 million share repurchase program. Since its inception in 1999, we have repurchased a total of 28.0 million shares through this program. As of December 31, 2006 the maximum approximate dollar value of shares that may be purchased under the program was $63.6 million. In January 2007, we obtained an authorization from the Board of Directors to repurchase an additional $236.4 million of common stock for a total current authorization of up to $300 million.

 

As of February 16, 2007, 72,329,748 shares of IndyMac Bancorp, Inc.’s common stock were held by approximately 1,797 shareholders of record.

 

DIVIDEND POLICY

 

Indymac’s goal is to maintain a dividend payout ratio in line with other financial institution payout ratios, which range from 30% to 50% of earnings per share. For 2006, Indymac’s dividend payout ratio was 39%.

 

Cash dividends declared were as follows during 2006 and 2005:

 

 

 

 

In 2006 and 2005, we funded the payment of dividends primarily from the dividend from Indymac Bank and cash on hand at the Company. The future principal source of funds for the dividend payments is anticipated to be the dividends we will receive from Indymac Bank. The payment of dividends by Indymac Bank is subject to regulatory requirements and review. See the “Capital Distribution Regulations” section on page 12 for further information. There is no assurance that the Bank will be able to pay dividends to the holding company in the future.

 

EQUITY COMPENSATION PLANS INFORMATION

 

The equity compensation plans information required by this Item 5 is hereby incorporated by reference to Indymac Bancorp’s definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of our 2006 fiscal year.

 

 

 

 

 

 

 

The following discussion and analysis should be read in conjunction with our consolidated financial statements, and the notes thereto and the other information incorporated by reference herein.

 

OVERVIEW

 

Indymac is a leading hybrid thrift/mortgage banking company. We offer a wide range of home mortgage products to a broad customer base using a technology-based approach. Indymac is structured to achieve synergies among its operations and to enhance customer service. The Company conducts business substantially through IndyMac Bank, F.S.B. via two primary operating segments, the mortgage banking and the thrift segments. On the mortgage banking side, we generate earnings largely by originating, securitizing and selling loans and securities at a profit and by servicing loans for others. On the thrift side, we generate core spread income from our investment portfolio of prime SFR mortgages, home equity loans, consumer and builder construction loans and mortgage-backed securities. The combination of mortgage banking and thrift investing has proven to be a powerful business model for Indymac, and, given our strong execution in the past, we have been able to outperform our peers and produce both strong and relatively stable returns on our shareholders’ equity.

 

2006 was a challenging year in the mortgage banking industry. This was the third year since the industry peaked, and industry loan volumes of $2.5 trillion were 34% below 2003’s historic high level and 17% lower than in 2005. Mortgage banking revenue margins declined further after sharp declines in 2005, and net interest margins continued to compress, as the yield curve inverted with the average spread between the 10-year Treasury yield and the 1-month LIBOR declining from 89 basis points in 2005 to negative 31 basis points in 2006. To cap it off, the housing industry slowed down significantly, increasing loan delinquencies and non-performing assets and driving up credit costs for all mortgage lenders.

 

Yet, despite these challenges, Indymac again reached new performance heights in 2006, achieving:

 

 

Net revenues of $1.3 billion for 2006 reflect an increase of 22% over 2005. Key drivers of this growth included the following:

 

1) Growth in average interest earning assets of 32% from $19.6 billion in 2005 to $26.0 billion in 2006, leading to an increase in net interest income of 24% to $526.7 million. The increase is primarily driven by the growth in production, increased retention of securities and loans in our held for investment portfolio, offset by the sale of loans. Net interest margin declined from 2.16% to 2.02% during a period of inverted yield curve. Factors contributing to this decline included higher cost of funds and hedging cost, higher premium amortization and increased non-performing loans. This decline somewhat mitigated the positive impact from the growth in average interest earning assets.

 

2) Growth in mortgage production of 48% in 2006 over 2005 to a record high of $90.0 billion, led to a 51% increase in loans sold to $79.0 billion. Our market share increased from 2.01% in 2005 to 3.58% in 2006. Leading this growth were our Financial Freedom and conduit channels with increases in production of 71% and 90%, respectively. This volume growth mitigated a decline in the MBR margin on loans sold, resulting from a decline in higher margin pay option ARM volume and a higher mix of lower margin conduit and correspondent channel volume. The MBR margin on loans sold was 1.06% in 2006, down from 1.36% in 2005.

 

3) Provision for loan loss increased from $10.0 million for 2005 to $20.0 million for 2006 mainly due to an increase in our non-performing assets as delinquencies worsened. The allowance for loan losses currently represents 4.9 times net charge-offs, down from 7.2 times at December 31, 2005 as net charge-offs for 2006 increased 4 basis points to 0.14% of average loans held for investment.

 

4) Service fee income of $101.3 million in 2006 grew 129% over 2005 driven by the increase in the principal balance of loans serviced for others combined with solid hedging performance and slowing prepayments attributable to higher mortgage rates.

 

Operating expenses of $789.0 million reflected an increase of 28%, consistent with the growth in our operations and infrastructure investments in order to execute on our strategy to increase production and revenue. During 2006, we opened three new regional centers, which increased our total regional centers to 16 at December 31, 2006. In addition, average FTE increased 27% from 6,240 to 7,935 during the year supporting this growth.

 

The effective tax rate on earnings for the year ended December 31, 2006 decreased to 39.1% from the 39.5% for the year ended December 31, 2005. The decline was due to a lower blended state tax rate as the Company further expanded geographically into states with lower tax rates. The effect of the decline on the net deferred tax liability further reduced the effective tax rate for the year ended December 31, 2006 to 38.3%.

 

SUMMARY OF BUSINESS SEGMENT RESULTS

 

Our mortgage banking segment consists of the following divisions:

 

The thrift segment includes the following divisions:

 

 

The tables below summarize the year-over-year performance of Indymac’s divisions. Detailed operating results for each division are provided on pages 24 to 27:

 

 

 

 

 

 

Total capital deployed in our operating business segments increased 47% to $1.6 billion in 2006 and earned a 28% return on equity before the impact of corporate overhead. Net of corporate overhead and including the excess undeployed capital, Indymac’s average capital of $1.8 billion earned a 19% return on equity for 2006.

 

We deployed 31% of our capital, or $552.8 million, into our Mortgage Production Divisions in 2006, an increase of 52% over 2005. Mortgage production earnings grew 8%; however the return on equity declined from 74% to 52% reflecting the narrower mortgage banking revenue margins. The wholesale and correspondent divisions reported stronger production year-over-year, but a reduction in net income as margins were lower in these two business lines year-over-year. Our conduit division had a strong year with earnings growth of 147% mainly attributable to growth in production of 90%, while return on equity increased to 34% from 24%. Our reverse mortgage division continued to demonstrate strong returns with earnings and production growth of 118% and 71%, respectively. In addition, return on equity increased from 39% in 2005 to 56% in 2006. The strong returns in this business are reflective of the strong growth in demographics for the seniors market and the growing popularity of the reverse mortgage product. In light of the intensifying competition in the reverse mortgage market, the division will focus on improving its efficiency and thus improving its costs to originate. We expect the division to continue to grow in the future and expect it to maintain its industry leadership position in the reverse mortgage market.

 

We deployed 21% of our capital, or $370.5 million, into the MSRs and Other Retained Assets division, up from 14% one year ago, while return on equity at 25% remained flat. We target our pricing and hedging strategies to earn expected ROE of 18% to 23% for this segment. Given the volatility in this segment, returns in a quarter may substantially exceed or fall below the targeted level.

 

We deployed 38% of our capital, or $675.5 million, to the Thrift segment, a 29% increase over last year. Thrift’s return on equity declined from 26% to 20% over the same period. Net interest margin declined from 1.95% to 1.75% during a period of inverted yield curve. Factors contributing to the decline included higher cost of funds and hedging cost, higher premium amortization and increased non-performing loans. As a result, net interest income increased by only 12% in spite of the 25% increase in average interest earning assets. Additionally, provision for loan losses and write-downs on residual securities increased substantially due to worsening credit quality of our portfolio and the collateral supporting the residual securities.

DETAIL CHANNEL SEGMENT RESULTS

 

The following tables summarize the Company’s financial results for the years ended December 31, 2006 and 2005 by its two primary segments via each of its operating divisions: