IndyMac Seems Hardy Enough to Survive

Updated from 11:02 a.m. EDT

As part of its quarterly financial analysis, TheStreet.com Ratings took a look at Dec. 31 regulatory filings, to analyze asset quality and reserve coverage for the nation's largest 20 banks and thrifts. Please click here for the tables and a brief discussion of other S&Ls.

IndyMac Bank, FSB (held by IndyMac Bancorp Inc. (IMB Quote)), had the highest ratio of nonperforming loans to core capital and reserves for the group, at 57.32% as of year-end.

The institution's nonperforming assets comprised 4.75% of total assets as of Dec. 31, up from 2.48% the previous quarter. Some of the increase in this ratio reflected IndyMac's balance sheet reduction, which is part of its strategy to free up capital to cover potential charge-offs of bad mortgages. Still, nonperforming assets increased 86% during the fourth quarter.

Nonperforming assets consist of loans past due 90 days or more, less government-guaranteed balances, along with repossessed real estate.

During IndyMac's earnings conference call for the fourth quarter, CEO Michael Perry stated that the thrift expected problem mortgages to peak late in 2008. He also pointed out that IndyMac's provisions for loan loss reserves during 2007 greatly outweighed its net charge-offs, and that this trend was expected to continue. By staying ahead of the charge-offs and shrinking the balance sheet, IndyMac expects to weather the storm and remain well capitalized. The holding company raised $676 million in capital in 2007, mainly by issuing preferred stock, and may seek to raise more capital in 2008.

IndyMac's ratio of loan loss reserves to nonperforming loans looks quite low, at 25.03%. However, most of its nonperforming loans were previously written down when they were transferred from held-for-sale to the thrift's loans-held-for-investment portfolio. According to IndyMac Bancorp's 10-K, these writedowns totaled $581 million, with $474 million essentially an embedded credit reserve for expected loan losses.

Of that $474 million, $304 million was for expected losses from nonperforming home equity loans and other second mortgages, where the loss rate is expected to be 100%.

This leaves a remaining "embedded reserve" of $170 million -- 20% of nonperforming first lien loans as reported in the fourth-quarter earnings presentation -- on top of the loan loss reserves of 25.03%.

So the big question is, are the institution's loan loss reserves at a reasonable level?

In its fourth-quarter slide presentation, IndyMac indicated that the average loan-to-value ratio for its first-lien mortgages was 76.4%. Consider the following example, with the numbers rounded a bit: A borrower who purchased a home for $250,000 has an unpaid loan balance of $190,000. If that loan goes through the foreclosure process and IndyMac can sell the property for $190,000 or more, it will avoid taking a loss, notwithstanding foreclosure expenses.

The loan loss reserves provide a further 25% cushion for home-price declines, meaning that in our example, IndyMac can sell the repossessed property for as little as $142,500 before taking a serious hit. This means the home could sell for as little as 57% of its original price.