by Peter G. Miller
February 15th, 2008
IndyMac Bancorp, Inc., through its Financial Freedom subsidiary, is said to be one of the largest reverse mortgage originators in the country.
In a brutally-frank letter to shareholders, Michael W. Perry, the company’s Chairman and Chief Executive Officer, had several things to say which are of interest:
___”2007 was a terrible year for our industry, for Indymac and for you, our owners. The 4th quarter of 2007 marked the eighth quarter of the current housing downturn (as measured by housing’s contribution to GDP), making it already the fourth worst housing downturn in modern times, and many now predict that, before it turns around, it is going to be the longest and deepest since the Great Depression. Non-GSE mortgage lending (i.e., loans not sold to Fannie Mae and Freddie Mac or FHA/VA insured loans) has been devastated by the collapse of the private secondary market. This collapse in late summer was caused by significantly worsening mortgage credit fundamentals and tremendous uncertainty and fear among investors about declining housing prices and future credit losses. As a result of the housing bubble bursting, delinquencies and non-performing home loans increased rapidly in 2007. Importantly, as I write this note nearly all housing industry participants … from home builders and home buying and selling consumers, to lenders, to investors … are pessimistic about the near-term outlook for the housing and mortgage markets, and, as often happens, market expectations can become self-fulfilling.”
Later, the Perry letter says:
___”While I said that we made mistakes, we also got some big things right: (1) we converted our entire business into a Federal thrift structure, saving us from the liquidity event risk of our previous mortgage REIT structure and what Countrywide and other mortgage industry participants experienced; (2) we raised $676 million of equity capital at better terms than many major banks and investment banks before the crisis period worsened, and we did not repurchase any shares despite significant pressure to do so; (3) we bought Financial Freedom, the largest reverse mortgage lender in the nation, for $85 million in 2004, and this entity earned a record $53 million in 2007; and (4) we largely avoided subprime lending and laid off the bulk of our Alt-A and option ARM credit risk into the secondary market, including structuring most of our non-GSE transactions so that we have limited warranty exposure. In addition, our mortgage backed securities portfolio has no CDOs and no exposure to bond insurers. And, importantly, to date not one Indymac AAA Alt-A bond has been downgraded by any of the rating agencies, and we estimate that less than one-tenth of 1% of all AAA Alt-A bonds in the industry have been downgraded.”
Perry adds that:
___”As most of you know, throughout 2007, we cut products and production channels that contributed to our credit losses and, with respect to products, where there was no longer a secondary market into which to sell them. In 2007, we permanently discontinued two production channels, our mortgage banking conduit group and our homebuilder division, and one product, subprime loans not eligible to be sold to the GSEs. Entering 2008, we have made the decision to (1) eliminate all limited documentation lending above a 75% LTV and below a 680 FICO and all ARM loans with negative amortization as an option and (2) temporarily halt new consumer construction and lot financing, our jumbo reverse mortgage product for correspondent and non-core wholesale customers and virtually all new second and home equity lending programs (except for a de minimis amount produced in our deposit branch network). You may ask, “What does that leave you with in 2008?” It leaves us still with a pretty substantial and solidly profitable production model that we expect will produce over $40 billion in home loans (or roughly a 2% share of the USA market) in 2008. We will be a national lender to mortgage brokers, bankers and community financial institutions (combined, we call this our Mortgage Professionals Group) and a national retail home lender, with both channels offering FHA/VA, GSE and prime jumbo home loan products. In addition, we will still be one of the largest reverse mortgage lenders to seniors in the USA (if not the largest) via Financial Freedom.”
Perry also says:
___”The next part of our plan is to continue to maintain our status as a fundamentally safe and sound financial institution, and the key to that is staying well-capitalized (above 5% core and 10% total risk-based capital). Our capital levels clearly have declined as a result of the losses we have taken in establishing significant reserves for future credit losses, but we still have a solid cushion above the well-capitalized levels. Since we want to try to avoid diluting our existing shareholders by issuing new stock at a price well below book value per share, the key way for us to “raise” additional capital and increase our capital cushion is to suspend the dividend and shrink our balance sheet. By suspending our annual dividend of $1 per share, or roughly $81 million per year, and shrinking our balance sheet by roughly $4.6 billion, or 14%, from December 31, 2007 via the production cuts discussed above, some modest AAA MBS sales, increasing the speed at which we sell loans to the GSEs and normal portfolio runoff, we project that we can “raise” / “free up” roughly $400 million of additional capital (an amount that is substantial in relation to the current market value of the entire company today), and we believe we can accomplish this without “fire-selling” either the entire company or our reverse mortgage business, which should be a tremendous long-term asset for our shareholders. Based on these strategies and assuming our current financial projections for 2008, we expect our capital ratios to grow to over 7.25% core and 12.00% total risk-based by year-end.”
Give Mr. Perry credit, he tells it like it is.