IndyMac Wreck Could Lead to S&L Pile-Up

Updated from 10:18 a.m. EDT

IndyMac Bancorp's ( IMB) precipitous fall Monday is a bad sign for other savings and loans on the brink of financial disaster.

After the last session, IndyMac posted a "stakeholder letter" on the company's blog, announcing that it was no longer considered well-capitalized by its regulator, the Office of Thrift Supervision.

Unless it quickly raises capital or finds a way to sell major portions of its business, IndyMac can't survive for the next several quarters unless overall housing prices show some signs of life. A rebound in housing would make the mortgage-backed securities market much more liquid, supporting prices and curtailing writedowns. It would also help to stabilize IndyMac's loan quality and enable it to pare down its quarterly provisions for loan loss reserves.

Unless any of those things happen, however, IndyMac and other troubled S&Ls like Washington Mutual ( WM) and Downey Financial ( DSL) are in trouble, putting the OTS is in a very difficult position.

The regulator of the nation's approximately 815 federally chartered S&Ls has already seen the second-largest institution it supervised, Countrywide, acquired under duress by Bank of America ( BAC). And WaMu and Downey are both prime candidates for actions similar to IndyMac's.

Close to Throwing in the Towel

In order to be considered well-capitalized under regulatory guidelines, a bank or S&L needs to maintain a leverage ratio of at least 5% and a risk-based capital ratio of at least 10%. IndyMac's risk-based capital ratio, which takes loan quality into account, had fallen to 10.26% as of March 31.

IndyMac stated it was too early to announce just what its capital ratios were as of June 30, but the company did say that its second-quarter net loss was expected to exceed its first-quarter loss of $184 million. Shares fell more than 50% Tuesday, to 34 cents at their lowest point.

Shares of IndyMac, which traded as high as $31.32 in the past 52 weeks, were losing nearly half of their remaining value, falling 31 cents, or 44%, to 40 cents.

Following the lender's announcement, Fitch Ratings cut its long-term issuer default ratings for IndyMac further into junk territory. Research firms Friedman Billings Ramsey and RBC Capital Markets lowered their price targets on the stock all the way to $0.

On June 26, Sen. Charles Schumer (D., N.Y.) leaked to The Wall Street Journal copies of letters he sent to the OTS, the Federal Home Loan Bank of San Francisco and the Federal Housing Finance Board, the regulator of the Federal Home Loan Bank System, expressing concern about the condition of IndyMac.

This leak set off a bit of a firestorm, with IndyMac acknowledging the following Monday that it had experienced over $100 million in deposit withdrawals following the Journal's article. IndyMac also stated that "96% of our approximate total of $19 billion in deposits" was fully insured by the FDIC.

Still, Monday's announcement shows that pressure mounted for the OTS to take action. Since IndyMac is no longer considered well-capitalized, it faces a possible liquidity crisis, since under FDIC rules, it can't gather new deposits through brokers or renew brokered CDs. Brokered deposits comprised 37% of total deposits as of March 31.

IndyMac is waiting on word from the FDIC on its application to have the brokered deposits rule waived.

Bitter Steps

Acknowledging that it would be unable to sell assets -- and thus boost the capital ratios -- without incurring even larger net losses, IndyMac said Monday it would "curtail most new loan production." While the company will fund new loans with rates already locked-in, it will no longer accept most retail and wholesale mortgage applications.

Going forward, the lender will focus on originating FHA-guaranteed reverse mortgages, under its Financial Freedom lending program. IndyMac will also continue to run its 33 S&L branches in California and its loan-servicing operations.

As it exits most of its lending businesses, the company will lay off 3,800 out of its total 7,200 employees, expecting to reduce operating expenses "roughly 60%."

So the big question is, can these moves preserve IndyMac as a viable savings and loan?

IndyMac has been forced to cut back on its traditionally generous severance packages, but it will provide lead times of at least 30 days for departing employees, plus minimum pay of $20,000 for the notice period for employees with at least five years of service.

So the savings on operating expenses won't begin until the fourth quarter. Here's a quick look at the company's consolidated first quarter 2008 income statement:

Clearly, it is too early to tell if IndyMac can survive for several more quarters after its cost savings kick in. With quarterly operating expenses reduced to $126 million, the company would have still lost money in the first quarter. Of course, the quarterly provision for loan losses was greatly elevated, at $132 million, not to mention the $160 million loss on mortgage-backed securities writedowns.

Regulatory Fallout

IndyMac's fall heightens concerns for other S&Ls on the precipice.

Lehman Brothers downgraded Downey on Tuesday from overweight to equal weight, a hold equivalent. As we discussed in our look at California banks and thrifts, Downey's loan quality has been declining sharply each month.

BankUnited Financial ( BKUNA) is another thrift selling for less than a dollar a share, thanks to the lender's troubled option-payment adjustable-rate mortgage portfolio.

Last but not least, WaMu has been at the forefront of the entire mortgage crisis. We were skewered for saying so last August.

WaMu's two thrift charters had $354 billion in total assets as of March 31. This was 25% of total assets under the OTS' supervision, if we exclude Countrywide.

All eyes will be on WaMu on July 22, when it announces second-quarter earnings results.

Philip W. van Doorn joined TheStreet.com Ratings., Inc., in February 2007. He is the senior analyst responsible for assigning financial strength ratings to banks and savings and loan institutions. He also comments on industry and regulatory trends. Mr. van Doorn has fifteen years experience, having served as a loan operations officer at Riverside National Bank in Fort Pierce, Florida, and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a Bachelor of Science in business administration from Long Island University.

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