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IndyMac Seems Hardy Enough to Survive

It looks to have enough reserves to muddle through the housing crisis.

Updated from 11:02 a.m. EDT

As part of its quarterly financial analysis, 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


for the tables and a brief discussion of other S&Ls.

IndyMac Bank, FSB (held by

IndyMac Bancorp Inc.


), 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.

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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.

The level of reserving was certainly adequate during 2007, when IndyMac's net loan charge-offs for 2007 were a relatively low $66 million, or 0.53% of average loans.

IndyMac was forced to transfer most of its held-for-sale loans to its investment portfolio, because it traditionally focused on "Alt-A" mortgages. These are loans to individuals with strong credit scores, but with less documentation of income than required for the mortgages to be purchased by

Fannie Mae



Freddie Mac


(known as government-sponsored enterprises, or GSEs).

Starting last August when the mortgage crisis came to a boil, the secondary market for non-GSE mortgages dried up, and IndyMac started transferring loans from the held-for-sale category to its portfolio category and marking down the loans.

IndyMac has now switched to a "GSE production model," meaning it will steer clear of the "Alt-A" mortgages it concentrated on during the housing boom. By sticking with new lending that conforms to Fannie Mae and Freddie Mac guidelines, IndyMac will have a much easier time selling mortgages and controlling credit risk and the size of its balance sheet.

Another area of credit risk for IndyMac is its loan securitization. Mortgage-related securities were also written-down, with an "embedded reserve" of $1.26 billion. This left $6.1 billion in securities available-for-sale, as of Dec. 31.

Part of the risk associated with loan securitization is the requirement to repurchase loans from investors for various reasons, such as early payment default. On the holding company level, IndyMac repurchased $613 million in loans sold during 2007. This represented 0.86% of loans sold during the year.

As for risks associated with IndyMac's investment securities portfolio, Mr. Perry stated in his 2007 Shareholder Letter that the company's 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."

In its fourth-quarter earnings presentation, IndyMac projected 2008 mortgage production of $41.7 billion. While this is far less than the total loan production of $78 billion in 2007, the 2008 production will be mainly "conforming" mortgages, as discussed above. The company also projected "a small profit" for 2008.

IndyMac's efforts to ride out the mortgage storm make for a fascinating story that investors with long horizons, good timing and strong stomachs should continue to follow. The holding company provides a lot of information, which they discussed with us in detail.

Know What You Own

: IMB operates in the mortgage industry and some of the other stocks in its field include

Fannie Mae



Freddie Mac






Wells Fargo

(WFC) - Get Wells Fargo & Company Report


Bank of America

(BAC) - Get Bank of America Corporation Report


Washington Mutual

(WM) - Get Waste Management Inc. Report

. These stocks were recently trading at ($29.54, +12.31%), ($27.87, +10.07%), ($5.95, +8.18%), ($30.88, +6.12%), ($40.25, +6.17%) and ($11.08, +7.57%) respectively. For more on the value of knowing what you own, visit's

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Philip W. van Doorn is senior bank analyst for Ratings.