10-K 1 v38189e10vk.htm FORM 10-K Indymac Bancorp, Inc.
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-K
     
(Mark One)    
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the fiscal year ended December 31, 2007
or
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the transition period from           to          
 
Commission file number: 1-8972
INDYMAC BANCORP, INC.
(Exact name of registrant as specified in its charter)
 
     
Delaware
  95-3983415
(State or other jurisdiction of incorporation)   (I.R.S. Employer Identification No.)
888 East Walnut Street, Pasadena, California   91101-7211
(Address of principal executive offices)   (Zip Code)
 
Registrant’s telephone number, including area code:
(800) 669-2300
 
Securities registered pursuant to Section 12(b) of the Act:
 
     
Title of Each Class
 
Name of Each Exchange on Which Registered
 
Common Stock, $.01 Par Value
(including related preferred stock purchase rights)
  New York Stock Exchange
WIRES Units
(Trust Preferred Securities and Warrants)
  New York Stock Exchange
 
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, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer and large accelerated filer and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer þ Accelerated filer o Non-accelerated filer o Smaller reporting company  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, 2007, the aggregate market value of Common Stock held by non-affiliates of the registrant was approximately $2,126,645,122. 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 15, 2008, 80,894,900 shares of IndyMac Bancorp, Inc. Common Stock, $.01 par value per share, were outstanding.
 
DOCUMENTS INCORPORATED BY REFERENCE
Proxy Statement for the 2008 Annual Meeting — Part III
 


Table of Contents

 
INDYMAC BANCORP, INC.
2007 ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS
 
             
        Page
 
    Forward-Looking Statements     3  
  Business     3  
    Business Model     4  
      Segments     4  
         Mortgage Banking Segment     5  
           Mortgage Production Division     6  
           Mortgage Servicing Division     7  
         Thrift Segment     7  
           Portfolio Divisions     7  
         Discontinued Business Activities     8  
    Regulation and Supervision     8  
      General     8  
      Regulation of Indymac Bank     8  
         General     8  
         Qualified Thrift Lender Test     9  
         Regulatory Capital Requirements     9  
         Insurance of Deposit Accounts     10  
         Capital Distribution Regulations     10  
         Community Reinvestment Act and the Fair Lending Laws     10  
         Privacy Protection     10  
    Income Tax Considerations     10  
    Employees     10  
    Competition     11  
    Website Access to United States Securities and Exchange Commission Filings     11  
  Risk Factors     11  
  Unresolved Staff Comments     11  
  Properties     12  
  Legal Proceedings     12  
  Submission of Matters to a Vote of Security Holders     13  
 
PART II
  Market for IndyMac Bancorp, Inc.’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities     13  
  Selected Financial Data     16  
  Management’s Discussion and Analysis of Financial Condition and Results of Operations     19  
    Overview     19  
    Narrative Summary of Consolidated Financial Results     20  
    Summary of Business Segment Results     22  
      Mortgage Banking Segment     24  
         Mortgage Production Division     26  
         Mortgage Servicing Division     32  
      Thrift Segment     35  
         Mortgage-Backed Securities Division     37  
         SFR Mortgage Loans HFI Division     37  
         Consumer Construction Division     39  


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        Page
 
      Elimination & Other Segment     40  
      Corporate Overhead Segment     42  
      Discontinued Business Activities     42  
    Consolidated Risk Management Discussion     46  
      CAMELS Framework For Risk Management     47  
         Capital     47  
         Asset Quality     49  
         Management     55  
         Earnings     56  
         Liquidity     56  
         Sensitivity to Market Risk     59  
    Expenses     65  
    Prospective Trends and Future Outlook     66  
    Off-Balance Sheet Arrangements     66  
    Aggregate Contractual Obligations     67  
    Risk Factors That May Affect Future Results     68  
         Risks Related to Our Business Generally     68  
         Risks Related to Our Interest Rate Hedging Strategies     71  
         Risks Related to Our Valuation of Assets     73  
         Risks Related to Our Assumption of Credit Risk     74  
         Risks Related to Our Liquidity     76  
    Critical Accounting Policies and Judgments     77  
    Sensitivity Analysis     84  
    Regulatory Update     85  
    Other Considerations     85  
    Appendix A: Additional Quantitative Disclosures     86  
  Quantitative and Qualitative Disclosures About Market Risk     105  
  Financial Statements and Supplementary Data     105  
  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure     105  
  Controls and Procedures     105  
  Other Information     106  
 
PART III
  Directors and Executive Officers of the Registrant     106  
  Executive Compensation     106  
  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters     106  
  Certain Relationships and Related Transactions     106  
  Principal Accounting Fees and Services     106  
 
PART IV
  Exhibits, Financial Statement Schedules     106  
    Financial Statements     106  
    Exhibits     106  
    Signature     109  
 EXHIBIT 10.17
 EXHIBIT 10.18
 EXHIBIT 10.19
 EXHIBIT 10.20
 EXHIBIT 10.21
 EXHIBIT 10.22
 EXHIBIT 10.23
 EXHIBIT 21.1
 EXHIBIT 23.1
 EXHIBIT 31.1
 EXHIBIT 31.2
 EXHIBIT 32.1
 EXHIBIT 32.2
 EXHIBIT 99.1


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PART I
 
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. Words such as “anticipate,” “believe,” “estimate,” “expect,” “project,” “plan,” “forecast,” “intend,” “goal,” “target,” and similar expressions, as well as future or conditional verbs, such as “will,” “would,” “should,” “could,” or “may,” 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, but not limited to, the level of housing prices, industry volumes and margins; the level and volatility of interest rates; Indymac’s hedging strategies, hedge effectiveness and overall asset and liability management; the accuracy of subjective estimates used in determining the fair value of financial assets of Indymac; the various credit risks associated with our loans and other financial assets, including increased credit losses due to demand trends in the economy and the real estate market and increased delinquency rates of borrowers; the adequacy of credit reserves and the assumptions underlying them; the actions undertaken by both current and potential new competitors; the availability of funds from Indymac’s lenders, loan sales, securitizations, funds from deposits and all other sources used to fund mortgage loan originations and portfolio investments; the execution of Indymac’s business and growth plans and its ability to gain market share in a significant and turbulent market transition. Additional risk factors include the impact of disruptions triggered by natural disasters; pending or future legislation, regulations and regulatory action, or litigation, and 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. Indymac does not undertake to update or revise forward-looking statements to reflect the impact of circumstances for events that arise after the date the forward-looking statements are made.
 
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.
 
ITEM 1.   BUSINESS
 
IndyMac Bancorp, Inc. is the holding company for IndyMac Bank, F.S.B., a $33 billion hybrid thrift/mortgage bank, headquartered in Pasadena, California. Indymac Bank originates mortgages in all 50 states of the U.S. and is the (1) largest savings and loan headquartered in Los Angeles County, California, and the seventh largest nationwide, based on assets according to American Banker, (2) the second largest independent mortgage lender in the nation according to National Mortgage News, (3) the ninth largest residential mortgage originator, based on third quarter 2007 mortgage origination volume according to National Mortgage News, and (4) the eighth largest mortgage servicer, according to National Mortgage News as of September 30, 2007. Indymac Bank provides cost-efficient financing for the acquisition of single-family homes and also provides financing secured by single-family homes and other banking products to facilitate consumers’ personal financial goals. We originate mortgage loans through our e-MITS® (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 tailored to meet the needs of both consumers and mortgage professionals.
 
Indymac 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 during 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


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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 U.S., 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 were purchased by us from Financial Freedom’s chief executive officer, James Mahoney, on July 3, 2006. The acquisition was consummated as part of our strategy to offer niche mortgage products and servicing a broad customer base.
 
BUSINESS MODEL
 
Indymac’s hybrid thrift/mortgage banking business model provides a strong framework and the flexibility to operate efficiently in varying interest-rate environments. Our businesses are aligned into two primary operating segments, mortgage banking and thrift. Mortgage banking involves the originating and trading of mortgage loans and related assets, as well as the servicing of these loans. Revenues from mortgage banking consist primarily of gains on the sale of the loans; interest income earned while the loans are held for sale; and servicing fee income. The thrift side of our business invests in single-family residential mortgage assets, primarily whole loan and mortgage-backed securities (“MBS”), which we hold on our balance sheet. Revenues from the thrift side of our business consists primarily of spread income, which represents the difference between the interest earned on the loans and the cost of funds.
 
Mortgage banking is less capital-intensive than thrift investing and offers higher returns on invested capital. However, mortgage banking is cyclical: origination volumes are significantly correlated to interest rates, rising when rates fall and declining 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., loan payoffs) is reduced. Thrift profitability is also more exposed to credit risk as we retain credit risk on most thrift assets. Significant changes in the asset quality after acquisition impact returns.
 
During 2007, there has been an unprecedented disruption in the U.S. mortgage market. Secondary markets for virtually every loan type other than GSE and government guaranteed loan has virtually ceased to exist. Numerous originators have failed and remaining lenders have dramatically tightened lending guidelines.
 
This disruption has resulted in home prices declining in virtually all markets in the U.S. The combination of significantly reduced lending activity and declining home prices has contributed to increasing delinquencies and foreclosures nationally. These increased loan defaults have been particularly severe in higher LTV lending products and in second lien products.
 
These market factors have had a dramatic impact on our business and results both from declining volumes and increased expectations of credit losses. These factors make comparisons to prior years very difficult.
 
SEGMENTS
 
Indymac is structured to achieve synergies among its operations and to enhance customer service, operating through its two main segments, mortgage banking and thrift. The common denominator of our 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 “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Summary of Business Segment Results” and “Note 3 — Segment Reporting” included in our consolidated financial statements incorporated herein.


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MORTGAGE BANKING SEGMENT
 
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 prime mortgage products to our customers using a technology-based approach across multiple channels on a nationwide basis supported by 11 strategically distributed regional mortgage centers. Our broad product offering includes adjustable-rate mortgages (“ARMs”), intermediate term fixed-rate loans, pay option ARMs offering borrowers multiple payment options, fixed-rate mortgages, and reverse mortgages.
 
Our largest production channel, the mortgage professionals group (“MPG”), originates or purchases mortgage loans through its relationships with mortgage brokers, mortgage bankers, and financial institutions. In April 2007, we acquired the retail platform of New York Mortgage Company (“NYMC”) and hired over 1,400 retail lending professionals. 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 bank branches.
 
We sell mortgage loans, which are usually 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. The continued severe disruption in the secondary market for loans and securities not sold to the GSEs has caused us to rapidly change our production business model from a primary focus on non-GSE mortgage banking to a model that now produces production that is 75%-85% eligible for sale to the GSEs.
 
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 principal-only securities, AAA-rated senior securities, securities associated with prepayment charges and late fee charges on the underlying mortgage loans, subordinated classes of securities, residual securities, cash reserve funds, or an over collateralization account. Other than MSRs, AAA-rated interest-only and principal-only securities, AAA-rated senior securities, and the securities associated with prepayment charges and late fees on the underlying mortgage loans, 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


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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 13 — Transfers and Servicing of Financial Assets” in the accompanying notes to consolidated financial statements for additional information.
 
Mortgage Production Division
 
Consumer Direct Division
 
This division markets mortgage products directly to existing and new consumers nationwide through direct mail, Internet lead aggregators, outbound telesales, online advertising, and referral programs, as well as through our Southern California retail bank branches.
 
Through our call center operations and our Southern California retail bank 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 mortgage centers.
 
Mortgage Professionals Group
 
Our largest production division, the MPG, was responsible for 62% of our total mortgage production during 2007. 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, realtors, and homebuilders, and is composed of two channels: retail, and mortgage broker and banker.
 
Mortgage loans could be either funded by us or purchased by us as closed loans on a flow basis from mortgage bankers or community financial institutions. 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 mortgage 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 capability and high customer service standards.
 
The retail lending group, a channel of the MPG, provides mortgage financing primarily to home purchase oriented consumers by targeting realtors, homebuilders and financial professionals via storefront mortgage loan offices. As of December 31, 2007, we had 182 retail mortgage offices.
 
During 2007, in light of the current market conditions, Indymac’s MPG did not open any additional regional wholesale mortgage centers. We had 16 regional mortgage centers as of December 31, 2007. We have decided to close five regional wholesale mortgage centers, including Tampa, Philadelphia, Boston, Columbia (South Carolina) and Kansas City, and consolidate these mortgage operations into our remaining 11 regional wholesale mortgage wholesale centers by the end of the first quarter of 2008.
 
Financial Freedom Division
 
Financial Freedom is the leading provider of reverse mortgages in the United States. This group is responsible for the origination, purchase and servicing of reverse mortgage products with senior customers via a retail loan


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officer sales force and a mortgage banker and broker relationship 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). Comparing 2007 to 2006, our reverse mortgage volume decreased 6% to $4.7 billion in 2007 from $5.0 billion in 2006 primarily due to the expected increased competition and the secondary market disruption in the later half of 2007. As a result, margin for this product was negatively impacted. However, 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.
 
Mortgage Servicing Division
 
This division manages the assets we retain in conjunction with our mortgage loan sales. The assets held include the following: (i) MSRs, interest-only securities, prepayment penalty securities and late fee 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; and (iii) loans acquired through clean-up calls or originated through our customer retention programs. We hedge the MSRs to protect the economic value of the MSRs.
 
At December 31, 2007, primarily through our Home Loan Servicing operation in Kalamazoo, Michigan, we serviced $198.2 billion of mortgage loans, of which $181.7 billion was serviced for others, an increase of 30% from $139.8 billion serviced for others in 2006. The servicing portfolio includes prime loans, 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 SEGMENT
 
The strategy of our thrift segment has been to leverage our capital infrastructure with prudent mortgage related asset growth to diversify company-wide earnings, targeting a return on equity exceeding the cost of both core and risk-based capital. The thrift segment principally invests in single-family residential (“SFR”) mortgage loans (predominantly prime ARMs, including intermediate term fixed-rate loans), mortgage-backed securities and construction financing for single-family residences or lots provided directly to individual consumers. 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 loans.
 
Portfolio Divisions
 
Mortgage-Backed Securities Division
 
MBS includes predominantly AAA-rated private label MBS.
 
SFR Mortgage Loans HFI Division
 
Single-family residential mortgage loans held for investment (“HFI”) are generally originated or acquired through our mortgage banking production divisions and transferred to the thrift. Held for investment loans may also be acquired from third party sellers and such loans are typically prime loans. The thrift attempts to invest in loans on


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which it can earn an acceptable return on equity. This division had significant asset growth in 2007 as we transferred a significant amount of loans from held for sale as market conditions made the sale of these loans uneconomic.
 
Consumer Construction Division
 
Our consumer construction 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. We earn 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 loans HFI division. 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 professional group and the remaining 32% of new commitments are retail originations. Beginning in 2008, we have temporarily suspended production in this division to reduce our balance sheet size.
 
DISCONTINUED BUSINESS ACTIVITIES
 
As conditions in the U.S. mortgage market have deteriorated, we have exited certain production channels and are reporting them in a separate category in our segment reporting, “Discontinued Business Activities”. These exited production channels include the conduit, homebuilder and home equity channels. These activities are not considered discontinued operations pursuant to Generally Accepted Accounting Principles (“GAAP”) under Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”) due to our significant continuing involvement in these activities. For additional information, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Summary of Business Segment Results — Discontinued Business Activities.”
 
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


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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 capital, and risk-based capital. In general, an association’s tangible capital, which must be at least 1.5% of tangible 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 (core) 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 risk-based capital equal to at least 4% of risk-weighted assets and total risk-based 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 consists mainly of qualifying subordinated debt, preferred stock that does not meet Tier 1 capital requirements, and a portion of the 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 Tier 1 (core) capital ratio of 5% or greater. Indymac Bank currently meets 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” to “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.


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Insurance of Deposit Accounts
 
Deposits of the Bank are presently insured 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 1.14 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 22 — Regulatory Requirements” in the accompanying notes to our 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, 2007, we had 9,907 full-time equivalent employees (“FTE”), including 870 FTE off-shore as part of our Global Resources program.


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COMPETITION
 
While the current disruptions in the housing and credit markets have reduced the number of competitors, we still face significant competition for lending volume. Many of our competitors are larger and enjoy both financial and customer awareness advantages over us. In addition, the reduction in salability of many mortgages has caused us to temporarily discontinue certain lending products that many of our competitors are able to originate.
 
While we believe that our current plans and strategies will allow us to compete in the market, there can be no assurance that we will succeed and as a result, our financial results could be materially worse than we expect.
 
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.imb.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.imb.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.
 
ITEM 1A.   RISK FACTORS
 
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 That May Affect Future Results.”
 
ITEM 1B.   UNRESOLVED STAFF COMMENTS
 
None.


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ITEM 2.   PROPERTIES
 
Our significant leased properties are as follows:
 
                     
        Approximate
    Principal Lease
 
Purpose
 
Location
  Square Feet     Expiration  
 
Corporate Headquarters/Administration
  Pasadena, California     192,000       2010  
Corporate Headquarters/Administration*
  Pasadena, California     179,000       2016  
Mortgage Banking Headquarters
  Pasadena, California     190,000       2017  
Corporate IT
  Tempe, Arizona     28,500       2015  
Home Loan Servicing — Customer Service and Loan Administration
  Kalamazoo, Michigan     46,000       2013  
Home Loan Servicing — Master Servicing and Investor Reporting
  Austin, Texas     106,000       2012  
Consumer Cross-Sell and Retention Headquarters; Mortgage Bank Operations; Financial Freedom Headquarters, Legal/Administration
  Irvine, California     138,000       2012  
Regional Mortgage Banking Center, Consumer Direct Operations and Sales
  Kansas City, Missouri     53,000       2009  
Regional Mortgage Banking Center, Consumer Direct Operations and Sales
  Overland Park, Kansas     21,000       2009  
Regional Mortgage Banking Center
  Ontario, California     41,500       2012  
Regional Mortgage Banking Center
  San Ramon, California     46,500       2010  
Regional Mortgage Banking Center
  Atlanta (Norcross), Georgia     67,500       2009  
Regional Mortgage Banking Center
  Scottsdale, Arizona     46,000       2009-2011  
Regional Mortgage Banking Center
  Marlton, New Jersey     62,000       2012  
Regional Mortgage Banking Center
  East Norriton, Pennsylvania     39,000       2011  
Regional Mortgage Banking Center
  Columbia, South Carolina     36,000       2009  
Regional Mortgage Banking Center
  Dallas (Irving), Texas     41,000       2008  
Regional Mortgage Banking Center
  Seattle (Bellevue), Washington     31,000       2008  
Regional Mortgage Banking Center
  Sacramento (Rancho Cordova), California     34,000       2012  
Regional Mortgage Banking Center
  Tampa, Florida     34,000       2013  
Regional Mortgage Banking Center
  Chicago (Schaumburg), Illinois     62,000       2013  
Regional Mortgage Banking Center
  Boston (Quincy), Massachusetts     26,000       2013  
Eastern Operations Center — Financial Freedom
  Atlanta, Georgia     44,000       2012  
Western Operations Center — Financial Freedom
  Sacramento (Roseville), California     55,000       2008-2009  
Loan Servicing, Accounting and Finance — Financial Freedom
  San Francisco, California     23,000       2008  
Retail Lending Group
  182 locations in various states     494,000       2008-2013  
Consumer Bank Retail Operations
  28 locations in Southern California     101,000       2008-2017  
Other Sales Offices and Locations
  55 locations in various states     48,000       2008-2010  
 
 
* 5,203 square feet relates to a Consumer Bank Retail Operation
 
In addition to the above leased office space, we 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.
 
ITEM 3.   LEGAL PROCEEDINGS
 
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,


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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 20 — Commitments and Contingencies” in the accompanying notes to consolidated financial statements for further discussion.
 
ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
No matters were submitted to a vote of shareholders during the quarter ended December 31, 2007.
 
PART II
 
ITEM 5.   MARKET FOR INDYMAC BANCORP, INC.’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
STOCK INFORMATION
 
IndyMac Bancorp, Inc.’s common stock is traded on the New York Stock Exchange (“NYSE”) under the symbol “IMB” effective May 1, 2007. Previously, it was trading 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, 2007 and 2006:
 
                                 
    2007     2006  
    High
    Low
    High
    Low
 
    ($)     ($)     ($)     ($)  
 
First Quarter
    45.82       26.27       43.24       37.71  
Second Quarter
    37.50       28.37       50.50       40.44  
Third Quarter
    31.50       16.86       47.24       37.15  
Fourth Quarter
    25.38       5.75       48.14       40.35  
 
ISSUANCE OF COMMON STOCK
 
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, 2007, we issued 7,427,104 shares of common stock at an average market price of $19.60 through this plan, as compared to the year ended December 31, 2006, for which we issued 3,532,360 shares of common stock at an average market price of $42.04 through this plan.


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SHARE REPURCHASE ACTIVITIES
 
The following summarizes share repurchase activities during the three months ended December 31, 2007:
 
                                 
                Total Number of
    Maximum Approximate
 
    Total
          Shares Purchased
    Dollar Value (In Million) of
 
    Number of
    Weighted
    as Part of Publicly
    Shares that may yet be
 
    Shares
    Average Price
    Announced Plans or
    Purchased Under the
 
    Purchased(1)     Paid per Share     Programs     Plans or Programs(2)  
 
Calendar Month:
                               
October 2007
        $           $ 300  
November 2007
    2,886       17.63             300  
December 2007
    375       8.48             300  
                                 
Total
    3,261       16.58             300  
                                 
 
 
(1) All shares purchased during the periods indicated represent withholding of a portion of shares to cover taxes in connection with vesting of restricted stock or exercise of stock options.
 
(2) 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. 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 15, 2008, 80,894,900 shares of IndyMac Bancorp, Inc.’s common stock were held by approximately 1,847 shareholders of record.
 
DIVIDEND POLICY
 
In light of the current financial performance of Indymac, the Board of Directors indefinitely suspended its quarterly cash dividend payments on our common stock beginning the first quarter of 2008.
 
For the years ended December 31, 2007 and 2006, we declared the following cash dividends:
 
                 
    Dividend
    Dividend
 
    per
    Payout
 
    Share     Ratio(1)  
 
2007
               
First Quarter
  $ 0.50       71 %
Second Quarter
  $ 0.50       83 %
Third Quarter
  $ 0.50       (18 )%
Fourth Quarter
  $ 0.25       (4 )%
2006
               
First Quarter
  $ 0.44       37 %
Second Quarter
  $ 0.46       31 %
Third Quarter
  $ 0.48       40 %
Fourth Quarter
  $ 0.50       52 %
 
 
(1) Dividend payout ratio represents dividends declared per share as a percentage of diluted earnings (loss) per share. This ratio was negative for the third and fourth quarters of 2007 due to the Company’s net loss and resulting diluted loss per share for those two periods.


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In 2007 and 2006, we funded the payment of dividends primarily from the dividend from Indymac Bank and cash on hand at the Parent 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 “Item 1. Business- Regulation and Supervision-Regulations of Indymac Bank-Capital Distribution Regulations” for further information. There is no assurance that the Bank will be able to pay dividends to the Company in the future.
 
EQUITY COMPENSATION PLANS INFORMATION
 
The equity compensation plans information required under 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 2007 fiscal year.


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ITEM 6.  SELECTED FINANCIAL DATA
(Dollars in millions, except per share data)
 
                                         
    Year Ended December 31  
    2007     2006     2005(2)     2004(2,3,4)     2003(2,4)  
 
Selected Balance Sheet Information (at December 31)(1)
                                       
Cash and cash equivalents
  $ 562     $ 542     $ 443     $ 356     $ 115  
Securities (trading and available for sale)
    7,328       5,443       4,102       3,689       1,838  
Loans held for sale
    3,777       9,468       6,024       4,446       2,573  
Loans held for investment
    16,454       10,177       8,278       6,750       7,449  
Allowance for loan losses
    (398 )     (62 )     (55 )     (53 )     (53 )
Mortgage servicing rights
    2,495       1,822       1,094       641       444  
Other assets
    2,516       2,105       1,566       997       874  
                                         
Total Assets
  $ 32,734     $ 29,495     $ 21,452     $ 16,826     $ 13,240  
                                         
Deposits
  $ 17,815     $ 10,898     $ 7,672     $ 5,743     $ 4,351  
Advances from Federal Home Loan Bank
    11,189       10,413       6,953       6,162       4,935  
Other borrowings
    652       4,637       4,367       3,162       2,622  
Other liabilities and preferred stock in subsidiary
    1,734       1,519       917       478       301  
                                         
Total Liabilities and Preferred Stock in Subsidiary
  $ 31,390     $ 27,467     $ 19,909     $ 15,545     $ 12,209  
                                         
Shareholders’ Equity
  $ 1,344     $ 2,028     $ 1,543     $ 1,280     $ 1,032  
                                         
Statement of Operations Information(1)
                                       
Net interest income
  $ 567     $ 527     $ 425     $ 405     $ 311  
Provision for loan losses
    (396 )     (20 )     (10 )     (8 )     (20 )
Gain (loss) on sale of loans
    (354 )     668       592       431       387  
Service fee income
    519       101       44       (12 )     (16 )
Gain (loss) on securities
    (439 )     21       18       (24 )     (31 )
Fee and other income
    107       50       37       27       19  
                                         
Net revenues
    4       1,347       1,106       819       650  
Total expenses
    (999 )     (791 )     (621 )     (483 )     (382 )
(Provision) benefit for income taxes
    380       (213 )     (192 )     (134 )     (107 )
                                         
Net earnings (loss)
  $ (615 )   $ 343     $ 293     $ 202     $ 161  
                                         
Operating Data
                                       
SFR mortgage loan production
  $ 76,979     $ 89,951     $ 60,774     $ 37,902     $ 29,236  
Total loan production(5)
    78,316       91,698       62,714       39,048       30,036  
Mortgage industry market share(6)
    3.30 %     3.30 %     2.01 %     1.37 %     0.77 %
Pipeline of SFR mortgage loans in process (at December 31)
  $ 7,506     $ 11,821     $ 10,488     $ 6,689     $ 4,116  
Loans sold
    71,164       79,049       52,297       31,036       23,176  
Loans sold/SFR mortgage loans production
    92 %     88 %     86 %     82 %     79 %
SFR mortgage loans serviced for others (at December 31)(7)
  $ 181,724     $ 139,817     $ 84,495     $ 50,219     $ 30,774  
Total SFR mortgage loans serviced (at December 31)
    198,170       155,656       90,721       56,038       37,066  
Average number of full-time equivalent employees (“FTEs”)
    9,518       7,935       6,240       4,715       3,882  
                                         
                                         
Per Common Share Data
                                       
                                         
                                         
Basic earnings (loss) per share(8)
  $ (8.28 )   $ 5.07     $ 4.67     $ 3.41     $ 2.92  
Diluted earnings (loss) per share(9)
    (8.28 )     4.82       4.43       3.27       2.88  
Dividends declared per share
    1.75       1.88       1.56       1.21       0.55  
Dividend payout ratio(10)
    (21 )%     39 %     35 %     37 %     19 %
Book value per share (at December 31)
  $ 16.61     $ 27.78     $ 24.02     $ 20.65     $ 18.17  
Closing price per share (at December 31)
    5.95       45.16       39.02       34.45       29.79  
Average shares (in thousands):
                                       
Basic
    74,261       67,701       62,760       59,513       55,247  
Diluted
    74,261       71,118       66,115       62,010       55,989  
                                         
                                         
Performance Ratios
                                       
                                         
                                         
Return on average equity
    (31.10 )%     19.09 %     21.23 %     17.38 %     17.02 %
Return on average assets
    (1.71 )%     1.17 %     1.38 %     1.20 %     1.38 %
Net interest margin, consolidated
    1.81 %     2.02 %     2.16 %     2.61 %     2.91 %
Net interest margin, thrift(11)
    2.16 %     2.11 %     2.27 %     2.15 %     1.78 %
Mortgage banking revenue (“MBR”) margin on loans sold(12)
    (0.22 )%     1.06 %     1.36 %     1.80 %     2.21 %
Efficiency ratio(13)
    244 %     58 %     55 %     58 %     57 %
Operating expenses to loan production
    1.24 %     0.86 %     0.99 %     1.24 %     1.27 %
                                         
                                         
Average Balance Sheet Data and Asset Quality Ratios
                                       
                                         
                                         
Average interest-earning assets
  $ 31,232     $ 26,028     $ 19,645     $ 15,521     $ 10,675  
Average assets
    35,969       29,309       21,278       16,871       11,712  
Average equity
    1,977       1,796       1,381       1,167       949  
Debt to equity ratio (at December 31)(14)
    16.2:1       13.5:1       12.9:1       12.1:1       11.8:1  
Tier 1 (core) capital ratio (at December 31)(15)
    6.24 %     7.39 %     8.21 %     7.66 %     7.56 %
Risk-based capital ratio (at December 31)(15)
    10.50 %     11.72 %     12.20 %     12.02 %     12.29 %
Non-performing assets to total assets (at December 31)
    4.61 %     0.63 %     0.34 %     0.73 %     0.76 %
Allowance for loan losses to total loans held for investment
(at December 31)
    2.42 %     0.61 %     0.67 %     0.78 %     0.71 %
Allowance for loan losses to non-performing loans held for investment
(at December 31)
    30.44 %     57.51 %     127.10 %     107.67 %     140.04 %


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(1) The items under the balance sheet and statement of operations sections are rounded individually and therefore may not necessarily add to the total.
 
(2) 2003-2005 data has been retrospectively adjusted to reflect the stock option expenses under Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share Based Payment” (“SFAS 123(R)”). Refer to “Note 23 — Benefit Plans” in the accompanying notes to our consolidated financial statements for further discussion.
 
(3) For the year ended December 31, 2004, the data is presented on a pro forma basis excluding the effect of change in accounting principle for rate lock commitments under Staff Accounting Bulletin No. 105, “Application of Accounting Principles to Loan Commitments” (“SAB 105”), effective April 1, 2004, and for the impact of the purchase accounting adjustments for Financial Freedom. The SAB 105 impact for the year ended December 31, 2004 was $59.5 million. Additionally, the impact of the purchase accounting adjustment for Financial Freedom totaled $7.9 million before-tax. The pro forma results are provided so that investors can evaluate our results on a comparable basis. A full reconciliation between the pro forma and GAAP amounts, with the relevant performance ratios, is as follows:
 
                         
    Year Ended December 31, 2004  
    GAAP     Adjustments     Pro Forma  
    (Dollars in millions, except per share data)  
 
Gain on sale of loans
  $ 364     $ 67     $ 431  
Net revenues
    751       67       818  
Other expense
    483             483  
Income taxes
    106       27       133  
                         
Net earnings
  $ 162     $ 40     $ 202  
                         
Diluted earnings per share
  $ 2.61     $ 0.66     $ 3.27  
ROE
    13.89 %             17.38 %
ROA
    0.96 %             1.20 %
 
(4) The Company previously classified the initial deferral of the incremental direct origination costs net of the fees collected on the loans as a net reduction in operating expenses. However, during 2005, we revised the presentation to reflect the deferral of the total fees collected as a reduction of fee and other income and the deferral of the incremental direct origination costs as a reduction of operating expenses. All prior periods were revised to conform to the current year presentation. This revision had no impact on reported earnings or the balance sheet in 2005 or in any prior period. Certain performance ratios based on net revenues or operating expenses were revised accordingly.
 
(5) Total loan production includes newly originated commitments on builder construction loans as well as commercial real estate loan production, which started in March 2007.
 
(6) Mortgage industry market share is calculated based on our total SFR mortgage loan production, both purchased (mortgage broker and banker) and originated (retail and mortgage broker and banker), in all channels (the numerator) divided by the Mortgage Bankers Association (“MBA”) February 15, 2008 Mortgage Finance Long-Term Forecast estimate of the overall mortgage market (the denominator). Our market share calculation is consistent with that of our mortgage banking peers. It is important to note that these industry calculations cause purchased mortgages to be counted more than once, i.e., first when they are originated and again by the purchasers (through financial institutions and conduit channels) of the mortgages. Therefore, our market share calculation may not be mathematically precise, but it is consistent with industry calculations, which we believe provides investors with a good view of our relative standing compared to our top mortgage lending peers.
 
(7) SFR mortgage loans serviced for others represent the unpaid principal balance on loans sold with servicing retained by Indymac. Total SFR mortgage loans serviced include mortgage loans serviced for others and mortgage loans owned by and serviced for Indymac.
 
(8) Net earnings (loss) divided by weighted average basic shares outstanding for the year.


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(9) Net earnings (loss) divided by weighted average diluted shares outstanding for the year. Due to the net loss for the year ended December 31, 2007, no potentially dilutive shares are included in the diluted loss per share calculation as including such shares in the calculation would be anti-dilutive.
 
(10) Dividend payout ratio represents dividends declared per share as a percentage of diluted earnings (loss) per share. This ratio was negative for 2007 due to the Company’s net loss and resulting diluted loss per share for the year.
 
(11) Net interest margin, thrift, represents the combined margin for thrift, elimination and other, and corporate overhead.
 
(12) Mortgage banking revenue margin is calculated using the sum of consolidated gain (loss) on sale of loans and the net interest income earned on loans held for sale by our mortgage banking production divisions divided by total loans sold.
 
(13) Efficiency ratio is defined as operating expenses divided by net revenues, excluding provision for loan losses.
 
(14) Total debt divided by total shareholders’ equity. For December 31, 2007, preferred stock in subsidiary is included in the calculation.
 
(15) The Tier 1 (core) capital ratio and risk-based capital ratio are for Indymac Bank and exclude unencumbered cash at the Parent Company available for investment in Indymac Bank. The risk-based capital ratio is calculated based on the regulatory standard risk weightings adjusted for the additional risk weightings for subprime loans.


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ITEM 7.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
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
 
The U.S. mortgage industry experienced unprecedented disruption in 2007. A combination of credit tightening and softening real estate prices throughout the U.S. has resulted in an industry-wide increase in delinquencies and foreclosures. Many mortgage lenders were forced to sell loans and securities at distressed prices, and many that were not depository institutions collapsed or were severely affected. As a result of this disruption, Indymac has made significant changes in its business model. We are currently expecting to originate a significant portion of our loans for sale to the GSEs as that market remains the only reliable secondary market, at present.
 
We have reduced our mortgage production by eliminating production channels and suspending products. We have suspended or eliminated many higher risk products, including high CLTV closed-end second liens and HELOCs, consumer and builder construction loans, and most non-conforming loan production. Also, we exited certain production channels, including the conduit channel, the homebuilder division and the home equity division. As a result, production results for 2007 show a significant decline from the prior year.
 
2007 was also severely impacted by worsening credit conditions as home prices and home sales declined. This has led to a significant increase in delinquencies in many products, particularly in higher loan-to-value (“LTV”) first and second lien loans and builder construction loans. As a result of the significantly worsening trends in home prices and loan delinquencies, we recorded significant charges, principally related to credit risk in our HFI portfolio, builder construction portfolio, and consumer construction portfolio. In addition, we recorded significant valuation adjustments in our loans held for sale, investment and non-investment grade securities and in residual securities. Finally, delinquency and repurchase demand trends, predominantly in our higher CLTV/LTV loan products, increased significantly.
 
As a result of these changes, virtually all of our operating segments, except for the mortgage servicing division and Financial Freedom, our reverse mortgage lending subsidiary, reported material losses in 2007. For the year ended December 31, 2007, Indymac had a consolidated net loss of $614.8 million. Regarding business segment performance1(, the mortgage production division had a net loss of $96.8 million in 2007 while the mortgage servicing division had earnings of $181.4 million. Combining mortgage production and servicing, the mortgage banking segment recorded net earnings of $33.0 million. The thrift segment recorded a net loss of $199.2 million for 2007 and our discontinued business activities recorded a net loss of $281.1 million. As a result of our thrift structure and strong capital and liquidity positions, we were not forced to sell assets at liquidation prices and our funding capacity was not materially impacted.
 
 
(1 Net income for the mortgage production division, mortgage servicing division and the thrift segment is before divisional and corporate overhead. Net income for the total mortgage banking segment is after divisional overhead but before corporate overhead.


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NARRATIVE SUMMARY OF CONSOLIDATED FINANCIAL RESULTS
 
Year ended December 31, 2007 Compared to Year ended December 31, 2006
 
The Company recorded a net loss of $614.8 million, or $8.28 loss per diluted share, for the year ended December 31, 2007, compared with net earnings of $342.9 million, or $4.82 per diluted share, for the year ended December 31, 2006. The decline in profitability is mainly attributable to higher credit costs and significant reduction in gain on sale of loans due to spread widening and illiquidity in the secondary mortgage market. We recorded $1.4 billion of credit costs for the year ended December 31, 2007 compared to $126.1 million for the year ended December 31, 2006. As a result, our total credit reserves increased to $2.4 billion at December 31, 2007 compared to $619 million as of December 31, 2006. See the “Asset Quality” section for further information on credit reserves.
 
SFR Mortgage Loan Production
 
Our total SFR mortgage loan production for the year ended December 31, 2007 dropped 14%, to $77.0 billion, as compared to $90.0 billion for 2006. This decline in volume is mainly reflected in the 47%, or $14.0 billion, drop in production from our conduit channel from 2006 as we exited this channel due to its inherently lower profit margins and the current uncertainty with respect to secondary market spreads and execution. Also, volume from the mortgage broker and banker channel declined by $1.7 billion, or 4%, from 2006 as we migrated our production efforts to focus primarily on GSE-eligible loans. Total SFR mortgage loan production, excluding the conduit channel, produced $60.9 billion in 2007, reflecting a slight increase of 2% from $59.9 billion in 2006. Our retail channel continued to grow with production reaching $2.0 billion this year, significantly up from $7.0 million in 2006. The servicing retention channel saw an increase of 70% from 2006. The pipeline of SFR mortgage loans in process ended at $7.5 billion, down 37% from $11.8 billion at December 31, 2006.
 
Mortgage Banking Revenue Margin
 
Net revenues for the Company declined to $3.6 million for 2007 compared to $1.3 billion for 2006. This decline in net revenues is primarily due to the decline in MBR margin caused by the secondary market disruption discussed earlier and higher credit costs due to worsening delinquencies in our held for sale (“HFS”), HFI and credit risk securities portfolios. Our MBR margin declined to a negative 0.22% for the year ended December 31, 2007 from a positive 1.06% for the year ended December 31, 2006. This year over year MBR margin decline was primarily due to higher credit costs and the change in product mix of loans sold.
 
In the fourth quarter of 2007, we transferred HFS loans with an original cost basis of $10.9 billion to HFI loans as we no longer intend to sell these loans given the extreme disruption in the secondary mortgage market. These loans were transferred at the lower of cost or market (“LOCOM”), and, accordingly, we reduced the cost basis by $0.6 billion, resulting in an increase in HFI loans of $10.3 billion. The $0.6 billion reduction was a combination of LOCOM reserves existing at the third quarter of 2007 and additional charges to the gain on sale of loans during the fourth quarter of 2007. Embedded in this reduction are estimated credit losses of $474 million.
 
During 2007, we sold a total of $71.2 billion in loans and recorded a loss on sale of $354.4 million. By comparison, we sold a total of $79.0 billion in loans during 2006, which generated $668.0 million in gain on sale.
 
Other Credit Costs
 
As discussed earlier, credit costs during the year ended December 31, 2007 significantly increased primarily due to higher delinquency and foreclosure rates in both our HFS and HFI portfolios. For the HFI portfolio, we increased the provision for loan losses to $395.5 million for the year ended December 31, 2007 compared to $20.0 million for the year ended December 31, 2006. We repurchased $613 million of loans for the year ended December 31, 2007, mainly due to early payment defaults, compared to $194 million during the year ended December 31, 2006. Based on delinquency trends and demand activity, we expect to repurchase additional loans in 2008 and beyond. Accordingly, we recorded a provision for the secondary market reserve of $232.5 million for the year ended December 31, 2007, compared to $37.3 million for the prior year.


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Non-interest Income
 
Total non-interest income, excluding gain on sale of loans, increased 9% from $171.9 million for the year ended December 31, 2006 to $186.7 million for the year ended December 31, 2007. This increase is largely due to the strong performance from our mortgage servicing division. Service fee income increased $417.9 million as a direct result of the growth in our servicing portfolio, slower prepayment rates and effective hedge performance. These increases were offset by a reduction in revenue from our mortgage-backed securities (“MBS”) portfolio. The MBS portfolio revenue declined from a gain of $20.5 million for the year ended December 31, 2006 to a loss of $439.7 million for the year ended December 31, 2007, primarily due to valuation adjustments on non-investment grade and residual securities.
 
Operating Expenses
 
Total operating expenses increased 23% from $789.0 million for the year ended December 31, 2006 to $973.7 million for the year ended December 31, 2007. The increase is primarily reflected in the 20% growth of our average FTEs from 7,935 for 2006 to 9,518 for 2007, which was necessary to support the expansion of our retail lending group and growth in loan servicing and default management functions. Contributing to the increase in expenses were REO related expenses, which increased by $42.2 million due to further write-downs on REOs resulting from the rapid decline in values, as well as higher foreclosures resulting from worsened delinquencies in our portfolio. In addition, we recorded severance charges of approximately $28 million in the third quarter of 2007 related to the reduction of our workforce.
 
Year ended December 31, 2006 Compared to Year ended December 31, 2005
 
Industry loan volumes of $2.7 trillion were 28% below 2003’s historic high level and 10% 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. 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 reached new performance heights in 2006, achieving:
 
  •  Record mortgage loan production of $90 billion, a 48% increase over 2005;
 
  •  Record mortgage market share of 3.30%, a 64% gain over the 2.01% share we had in 2005;
 
  •  Record net revenues of $1.3 billion, a 22% increase over 2005;
 
  •  Record earnings per share of $4.82, a 9% gain;
 
  •  Record growth in total assets, which increased by $8 billion, or 37%, to $29.5 billion;
 
  •  Record growth in our portfolio of loans served for others, which increased by $55 billion, or 65%, to 140 billion;
 
  •  Strong return on equity of 19%, slightly lower than last year’s 21% level.
 
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 was 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


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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. As of December 31, 2006, the allowance for loan losses represented 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 effective hedging performance and slowing prepayments attributable to reduced refinancing and home sales.
 
Operating expenses of $789.0 million in 2006 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.
 
SUMMARY OF BUSINESS SEGMENT RESULTS
 
Our segment reporting is organized consistent with our hybrid business model. Mortgage banking involves the origination, securitization and sale of mortgage loans and related assets, and the servicing of those loans. The revenues from mortgage banking consist primarily of gains on the sale of the loans, fees earned from origination, net interest income earned while the loans are held pending sale, and servicing fees. On the thrift side, we generate core spread income from our investment portfolio of prime SFR mortgage loans, MBS and consumer construction loans.
 
As conditions in the U.S. mortgage market have deteriorated, we have exited certain production channels and are reporting them in a separate category in our segment reporting, “Discontinued Business Activities” as a result of our continuing involvement with these activities. These exited production channels include the conduit, homebuilder and home equity channels. These activities are not considered discontinued operations as defined by SFAS 144. We segregated the business activities we have exited so that the segments represent our new business model. See the “Discontinued Business Activities” section for more information.
 
We have developed a detailed reporting process that computes net earnings and ROE for our key business segments each reporting period, and we use the results to evaluate our managers’ performance and determine their incentive compensation. In addition, we use the results to evaluate the performance and prospects of our divisions and adjust our capital allocations to those that earn the best returns for our shareholders.
 
We predominantly use GAAP to compute each division’s financial results as if it were a stand-alone entity. Consistent with this approach, borrowed funds and their interest cost are allocated based on the funds actually used by the Company to fund the division’s assets and capital is allocated based on regulatory capital rules for the specific assets of each segment. Additionally, transactions between divisions are reflected at arms-length in these financial results, and intercompany profits are eliminated in consolidation. We do not allocate fixed corporate and business unit overhead costs to our profit center divisions, because the methodologies to do so are arbitrary and would distort each division’s marginal contribution to our profits. However, the cost of these overhead activities is included in the following tables to reconcile to our consolidated results and is tracked closely, so the responsible managers can be held accountable for the level of these costs and their efficient use.
 
The following table and discussions explain the recent results of our two major operating segments, mortgage banking and thrift. These activities, combined with the eliminations and other category, which includes supporting deposit and treasury costs as well as eliminating entries and discontinued business activities, form our total operating results. Our unallocated corporate overhead costs are also presented and discussed. We have also included supplemental tables showing detailed division level financial results for each of our major operating segments.


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The following summarizes the Company’s financial results by segment for the years indicated (dollars in thousands):
 
                                                                 
    Mortgage
                Total
          Total
    Discontinued
       
    Banking
    Thrift
    Eliminations
    Operating
    Corporate
    On-Going
    Business
    Total
 
    Segment     Segment     & Other(1)     Results     Overhead     Businesses     Activities     Company  
 
Year Ended December 31, 2007
                                                               
Operating Results
                                                               
Net interest income
  $ 93,248     $ 234,865     $ 107,937     $ 436,050     $ (9,437 )   $ 426,613     $ 140,129     $ 566,742  
Provision for loan losses
          (185,919 )           (185,919 )           (185,919 )     (209,629 )     (395,548 )
Gain (loss) on sale of loans
    96,858       24,409       (168,083 )     (46,816 )           (46,816 )     (307,544 )     (354,360 )
Service fee income (expense)
    427,490             88,357       515,847             515,847       3,406       519,253  
Gain (loss) on securities
    (35,595 )     (339,010 )     (42,965 )     (417,570 )           (417,570 )     (22,143 )     (439,713 )
Gain on sale and leaseback of building
                            23,982       23,982             23,982  
Other income (expense)
    43,467       29,349       3,582       76,398       1,408       77,806       5,402       83,208  
                                                                 
Net revenues (expense)
    625,468       (236,306 )     (11,172 )     377,990       15,953       393,943       (390,379 )     3,564  
Operating expenses
    812,639       97,130       65,182       974,951       161,188       1,136,139       76,912       1,213,051  
Severance charges
                            31,850       31,850             31,850  
Pension curtailment gain
                            (10,335 )     (10,335 )           (10,335 )
Deferral of expenses under SFAS 91
    (244,421 )     (8,251 )     (78 )     (252,750 )           (252,750 )     (6,405 )     (259,155 )
                                                                 
Pre-tax earnings (loss)
    57,250       (325,185 )     (76,276 )     (344,211 )     (166,750 )     (510,961 )     (460,886 )     (971,847 )
                                                                 
Minority interests
    1,288       1,207       20,029       22,524       48       22,572       449       23,021  
                                                                 
Net earnings (loss)
  $ 32,964     $ (199,247 )   $ (65,797 )   $ (232,080 )   $ (101,599 )   $ (333,679 )   $ (281,129 )   $ (614,808 )
                                                                 
Performance Data
                                                               
Average interest-earning assets
  $ 8,386,138     $ 14,976,535     $ (88,143 )   $ 23,274,530     $ 553,740     $ 23,828,270     $ 7,403,916     $ 31,232,186  
Allocated capital
    823,308       670,476       4,325       1,498,109       58,570       1,556,679       420,253       1,976,932  
Loans produced
    58,217,003       2,988,322       N/A       61,205,325             61,205,325       17,111,059       78,316,384  
Loans sold
    59,148,675       6,363,003       (15,194,611 )     50,317,067             50,317,067       20,846,657       71,163,724  
MBR margin
    0.39 %     0.38 %     N/A       N/A       N/A       0.17 %     (1.17 )%     (0.22 )%
ROE
    4 %     (30 )%     N/A       (15 )%     N/A       (21 )%     (67 )%     (31 )%
Net interest margin
    N/A       1.57 %     N/A       1.87 %     N/A       1.79 %     1.89 %     1.81 %
Net interest margin, thrift
    N/A       1.57 %     N/A       N/A       N/A       2.16 %     N/A       N/A  
Average FTE
    7,173       436       333       7,942       1,241       9,183       335       9,518  
                                                                 
                                                                 
Year Ended December 31, 2006
                                                               
Operating Results
                                                               
Net interest income
  $ 80,721     $ 197,333     $ 76,139     $ 354,193     $ (8,737 )   $ 345,456     $ 181,265     $ 526,721  
Provision for loan losses
          (12,728 )           (12,728 )           (12,728 )     (7,265 )     (19,993 )
Gain (loss) on sale of loans
    616,594       42,649       (67,639 )     591,604             591,604       76,450       668,054  
Service fee income (expense)
    136,790             (35,939 )     100,851             100,851       466       101,317  
Gain (loss) on securities
    19,173       3,434       10,809       33,416             33,416       (12,934 )     20,482  
Other income (expense)
    12,268       26,771       (1,664 )     37,375       2,220       39,595       10,527       50,122  
                                                                 
Net revenues (expense)
    865,546       257,459       (18,294 )     1,104,711       (6,517 )     1,098,194       248,509       1,346,703  
Operating expenses
    685,867       81,720       49,009       816,596       168,697       985,293       72,160       1,057,453  
Deferral of expenses under SFAS 91
    (247,047 )     (8,812 )     (2,229 )     (258,088 )           (258,088 )     (8,158 )     (266,246 )
                                                                 
Pre-tax earnings (loss)
    426,726       184,551       (65,074 )     546,203       (175,214 )     370,989       184,507       555,496  
                                                                 
Net earnings (loss)
  $ 259,225     $ 112,394     $ (34,352 )   $ 337,267     $ (106,705 )   $ 230,562     $ 112,367     $ 342,929  
                                                                 
Performance Data
                                                               
Average interest-earning assets
  $ 6,291,661     $ 12,037,309     $ (89,838 )   $ 18,239,132     $ 588,649     $ 18,827,781     $ 7,200,495     $ 26,028,276  
Allocated capital
    636,786       536,943       2,108       1,175,837       182,550       1,358,387       437,873       1,796,260  
Loans produced
    56,802,029       2,937,596             59,739,625             59,739,625       31,958,199       91,697,824  
Loans sold
    54,536,739       2,666,610       (9,184,815 )     48,018,534             48,018,534       31,030,428       79,048,962  
MBR margin
    1.30 %     1.60 %     N/A       N/A       N/A       1.42 %     N/A       1.06 %
ROE
    41 %     21 %     N/A       29       N/A       17 %     26 %     19 %
Net interest margin
    N/A       1.64 %     N/A       1.94 %     N/A       1.83 %     2.52 %     2.02 %
Net interest margin, thrift
    N/A       1.64 %     N/A       N/A       N/A       2.11 %     N/A       N/A  
Average FTE
    5,586       473       314       6,373       1,232       7,605       330       7,935  
                                                                 
                                                                 
Year over Year Comparison
                                                               
% change in net earnings
    (87 )%     (277 )%     (92 )%     (169 )%     5 %     (245 )%     (350 )%     (279 )%
% change in capital
    29 %     25 %     105 %     27 %     (68 )%     15 %     (4 )%     10 %
 
 
(1) Included are eliminations, deposits, and treasury items. See the “Eliminations and Other Segment” section for details.


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MORTGAGE BANKING SEGMENT
 
Our mortgage banking segment primarily consists of the mortgage production division and the mortgage servicing division, which services the loans that Indymac originates, whether they have been sold into the secondary market or are held for investment on our balance sheet.
 
The mortgage banking segment reported net earnings of $33.0 million for the year ended December 31, 2007 compared with net earnings of $259.2 million in the prior year. These lower results were caused by a large decline in earnings from our mortgage production division, which reported a $96.8 million after-tax loss this year, partially offset by very strong returns and growth in the mortgage servicing division.
 
The primary driver of the loss in the mortgage production division in 2007 was the decline in the MBR margin from 1.29% of loans sold in 2006 to 0.32% of loans sold in 2007. A large increase in production credit costs was the primary cause of this decline. Mortgage banking revenue was reduced by $476.5 million in pre-tax credit related costs in 2007, representing a $377.6 million increase from $98.9 million in 2006. As credit conditions in the U.S. mortgage market have deteriorated, our loan production credit costs have increased. Thus, we discontinued the offering of products where these losses were concentrated. As a result, substantially all of the production credit losses we incurred in the fourth quarter of 2007 resulted from products we no longer offer.
 
In addition to the increased credit losses, the continued severe disruption in the secondary market for loans and securities not sold to the GSEs has caused us to rapidly change our production business model from a primary focus on non-GSE mortgage banking to a model that now produces production that is 75%-85% eligible for sale to the GSEs. This change in our business model has temporarily reduced the profitability of our production divisions, as we have worked to lower our costs and our salesforce has adapted to selling these GSE products.
 
The mortgage banking segment was also negatively impacted in 2007 as it includes two start-up businesses, the retail lending group and commercial mortgage banking division, which are currently unprofitable. These two businesses reported a combined after-tax loss of $38.8 million in 2007. We expect these businesses to contribute to mortgage banking profits in 2008.
 
The significant disruption in credit and housing markets that occurred during 2007 had a materially negative impact on our production results. These disruptions have resulted in higher non-GSE mortgage rates, significantly more restrictive underwriting guidelines and declining home prices, all of which worked to slow prepayments in our servicing portfolio. The loans in our servicing portfolio prepaid at an annual rate of 10% in 2007 compared with 20% in 2006. The expectation of slower non-GSE prepayments offset the impact of lower market interest rates and resulted in strong hedging results. As a result, the net income from our mortgage servicing division increased 174% from $66.1 million in 2006 to $181.4 million in 2007 and resulted in a 50% return on the approximately $400 million of capital we have invested in this division.


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The following provides details on total mortgage banking segment for the years indicated (dollars in thousands):
 
                                         
                Consumer
    Commercial
    Total
 
    Mortgage
    Mortgage
    Mortgage
    Mortgage
    Mortgage
 
    Production
    Servicing
    Banking
    Banking
    Banking
 
    Division     Division     O/H(1)     Division     Segment  
 
Year Ended December 31, 2007
                                       
Operating Results
                                       
Net interest income
  $ 132,086     $ (40,563 )   $ 853     $ 872     $ 93,248  
Provision for loan losses
                             
Gain (loss) on sale of loans
    45,872       56,124             (5,138 )     96,858  
Service fee income (expense)
    38,046       389,441             3       427,490  
Gain (loss) on securities
          (35,595 )                 (35,595 )
Other income (expense)
    29,543       12,986       701       237       43,467  
                                         
Net revenues (expense)
    245,547       382,393       1,554       (4,026 )     625,468  
Operating expenses
    632,431       97,073       73,998       9,137       812,639  
Deferral of expenses under SFAS 91
    (229,972 )     (13,619 )           (830 )     (244,421 )
                                         
Pre-tax earnings (loss)
    (156,912 )     298,939       (72,444 )     (12,333 )     57,250  
                                         
Minority interests
    604       627       28       29       1,288  
                                         
Net earnings (loss)
  $ (96,777 )   $ 181,427     $ (44,146 )   $ (7,540 )   $ 32,964  
                                         
Performance Data
                                       
Average interest-earning assets
  $ 7,135,160     $ 1,176,711     $ 2,427     $ 71,840     $ 8,386,138  
Allocated capital
    441,917       361,405       14,208       5,778       823,308  
Loans produced
    53,263,377       4,592,979             360,647       58,217,003  
Loans sold
    55,035,002       4,071,678             41,995       59,148,675  
MBR margin
    0.32 %     1.38 %     N/A       N/A       0.39 %
ROE
    (22 )%     50 %     N/A       (130 )%     4 %
Net interest margin
    1.85 %     N/A       N/A       1.21 %     N/A  
Average FTE
    5,433       281       1,420       39       7,173  
                                         
Year Ended December 31, 2006
                                       
Operating Results
                                       
Net interest income
  $ 91,648     $ (11,489 )   $ 562     $     $ 80,721  
Provision for loan losses
                             
Gain (loss) on sale of loans
    585,501       31,093                   616,594  
Service fee income (expense)
    21,141       115,649                   136,790  
Gain (loss) on securities
          19,173                   19,173  
Other income (expense)
    1,958       7,015       3,295             12,268  
                                         
Net revenues (expense)
    700,248       161,441       3,857             865,546  
Operating expenses
    564,200       60,894       59,997       776       685,867  
Deferral of expenses under SFAS 91
    (238,979 )     (8,068 )                 (247,047 )
                                         
Pre-tax earnings (loss)
    375,027       108,615       (56,140 )     (776 )     426,726  
                                         
Net earnings (loss)
  $ 227,739     $ 66,147     $ (34,189 )   $ (472 )   $ 259,225  
                                         
Performance Data
                                       
Average interest-earning assets
  $ 5,707,401     $ 581,789     $ 2,471     $     $ 6,291,661  
Allocated capital
    370,703       253,235       12,848             636,786  
Loans produced
    54,103,697       2,698,332                   56,802,029  
Loans sold
    52,480,834       2,055,905                   54,536,739  
MBR margin
    1.29 %     1.51 %     N/A       N/A       1.30 %
ROE
    61 %     26 %     N/A       N/A       41 %
Net interest margin
    1.61 %     N/A       N/A       N/A       N/A  
Average FTE
    4,324       201       1,060       1       5,586  
                                         
Year over Year Comparison
                                       
% change in net earnings
    (142 )%     174 %     (29 )%     N/A       (87 )%
% change in capital
    19 %     43 %     11 %     N/A       29 %
 
 
(1) Included mortgage production division overhead, servicing overhead and secondary marketing overhead of $(16.6) million, $(14.1) million and $(13.5) million, respectively, for the year ended December 31, 2007. For the year ended December 31, 2006, the mortgage production division overhead, servicing overhead and secondary marketing overhead were $(14.4) million, $(10.1) million and $(9.7) million, respectively.


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MORTGAGE PRODUCTION DIVISION
 
The mortgage production division originates loans through three divisions: mortgage professionals group (“MPG”), Financial Freedom and consumer direct. The MPG sources loans through relationships with mortgage brokers, financial institutions, Realtors, and homebuilders, and is composed of two channels: retail and mortgage broker and banker.
 
The consumer direct division offers mortgage loans directly to consumers via our Southern California retail branch network and our centralized call center, sourcing leads through direct mail, internet lead aggregators, online advertising and referral programs.
 
Within the MPG, the retail channel provides mortgage financing directly to home purchase oriented consumers by targeting Realtors®, homebuilders and financial professionals via storefront mortgage loan offices. With the goal of becoming a top 15 retail lender over the next five years, our April 2007 acquisition of the retail platform of NYMC and the hiring of retail lending professionals provide a model for this division. As of December 31, 2007, we have 182 retail mortgage offices/branches throughout the U.S.
 
Mortgage broker and banker is the largest channel in our MPG, funding loans originated through mortgage brokers and emerging mortgage bankers nationwide. This channel also purchases closed loans — those already funded — on a flow basis from mortgage brokers, realtors, homebuilders, mortgage bankers and financial institutions.
 
Financial Freedom provides reverse mortgage products directly to seniors (age 62 and older) and through the mortgage broker and banker channel. Through this division, we remain the leader in the fast growing reverse mortgage market. Financial Freedom also retains MSRs and receives fees and ancillary revenues for servicing loans sold into the secondary market.


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The following provides details on the results for the mortgage production division for the years indicated (dollars in thousands):
 
                                                 
          Mortgage Professionals Group              
                Mortgage
    Total
          Total
 
    Consumer
          Broker and
    Mortgage
    Financial
    Mortgage
 
    Direct
    Retail
    Banker
    Professionals
    Freedom
    Production
 
    Division     Channel     Channel     Group     Division     Division  
 
Year Ended December 31, 2007
                               
Operating Results
                                               
Net interest income
  $ 1,238     $ 4,324     $ 106,736     $ 111,060     $ 19,788     $ 132,086  
Provision for loan losses
                                   
Gain (loss) on sale of loans
    7,804       (1,511 )     (99,838 )     (101,349 )     139,417       45,872  
Service fee income (expense)
                            38,046       38,046  
Other income (expense)
    726       12,485       15,978       28,463       354       29,543  
                                                 
Net revenues (expense)
    9,768       15,298       22,876       38,174       197,605       245,547  
Operating expenses
    23,917       104,122       367,567       471,689       136,825       632,431  
Severance charges
                                   
Deferral of expenses under SFAS 91
    (10,856 )     (37,512 )     (153,973 )     (191,485 )     (27,631 )     (229,972 )
                                                 
Pre-tax earnings (loss)
    (3,293 )     (51,312 )     (190,718 )     (242,030 )     88,411       (156,912 )
                                                 
Minority interests
    7       46       319       365       232       604  
                                                 
Net earnings (loss)
  $ (2,013 )   $ (31,295 )   $ (116,466 )   $ (147,761 )   $ 52,997     $ (96,777 )
                                                 
Performance Data
                               
Average interest-earning assets
  $ 116,713     $ 171,477     $ 5,879,797     $ 6,051,274     $ 967,173     $ 7,135,160  
Allocated capital
    5,710       13,761       288,202       301,963       134,244       441,917  
Loans produced
    1,062,934       2,027,631       45,449,927       47,477,558       4,722,885       53,263,377  
Loans sold
    1,139,515       1,569,648       47,536,034       49,105,682       4,789,805       55,035,002  
MBR margin(1)
    0.79 %     0.18 %     0.01 %     0.02 %     3.32 %     0.32 %
ROE
    (35 )%     (227 )%     (40 )%     (49 )%     39 %     (22 )%
Net interest margin
    1.06 %     2.52 %     1.82 %     1.84 %     2.05 %     1.85 %
Average FTE
    266       1,005       2,814       3,819       1,348       5,433  
                                                 
Year Ended December 31, 2006
                                               
Operating Results
                                               
Net interest income
  $ 2,478     $ 30     $ 79,222     $ 79,252     $ 9,918     $ 91,648  
Provision for loan losses
                                   
Gain (loss) on sale of loans
    32,162       315       392,180       392,495       160,844       585,501  
Service fee income (expense)
                            21,141       21,141  
Other income (expense)
    469       336       1       337       1,152       1,958  
                                                 
Net revenues (expense)
    35,109       681       471,403       472,084       193,055       700,248  
Operating expenses
    54,248       3,654       371,052       374,706       135,246       564,200  
Deferral of expenses under SFAS 91
    (22,330 )     (98 )     (184,295 )     (184,393 )     (32,256 )     (238,979 )
                                                 
Pre-tax earnings (loss)
    3,191       (2,875 )     284,646       281,771       90,065       375,027  
                                                 
Net earnings (loss)
  $ 1,943     $ (1,751 )   $ 173,349     $ 171,598     $ 54,198     $ 227,739  
                                                 
Performance Data
                                               
Average interest-earning assets
  $ 202,035     $ 2,637     $ 4,885,249     $ 4,887,886     $ 617,480     $ 5,707,401  
Allocated capital
    10,814       131       263,328       263,459       96,430       370,703  
Loans produced
    1,922,448       35,845       47,121,871       47,157,716       5,023,533       54,103,697  
Loans sold
    1,968,766       31,548       45,982,168       46,013,716       4,498,352       52,480,834  
MBR margin(1)
    1.76 %     1.09 %     1.03 %     1.03 %     3.80 %     1.29 %
ROE
    18 %     N/M       66 %     65 %     56 %     61 %
Net interest margin
    1.23 %     1.14 %     1.62 %     1.62 %     1.61 %     1.61 %
Average FTE
    372       25       2,655       2,680       1,272       4,324  
                                                 
Year over Year Comparison
                                               
% change in net earnings
    (204 )%     N/M       (167 )%     (186 )%     (2 )%     (142 )%
% change in capital
    (47 )%     N/M       9 %     15 %     39 %     19 %
 
 
(1) MBR margin is calculated using the sum of consolidated gain (loss) on sale of loans and the net interest income earned on HFS loans by our mortgage production division divided by total loans sold. The gain (loss) on sale of loans includes fair value adjustments on HFS loans in our portfolio at the end of the year that are not included in the amount of total loans sold.


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The following summarizes the key production drivers for the mortgage broker and banker channel for the years indicated:
 
                                         
    Year Ended December 31  
                % Change
          % Change
 
    2007     2006     2007/2006     2005     2007/2005  
 
Key Production Drivers:
                                       
Active customers(1)
    8,294       7,927       5 %     6,728       23 %
Sales personnel
    1,140       1,025       11 %     712       60 %
Number of regional offices
    16       16             13       23 %
 
 
 
(1) Active customers are defined as customers who funded at least one loan during the most recent 90-day period.
 
Loan Production
 
Loan production and sales are the drivers of our mortgage banking segment. While the mortgage production division of our mortgage banking segment contributes 68% to our total loan originations, the following discussion refers to our total production, through both the mortgage banking and thrift segments and the discontinued business activities.
 
We generated SFR mortgage loan production of $77.0 billion for the year ended December 31, 2007, down $13.0 billion from the year ended December 31, 2006, and up $16.2 billion from the year ended December 31, 2005. Total loan production, including commercial real estate loans and builder financings, reached $78.3 billion for 2007, compared to $91.7 billion for 2006 and $62.7 billion for 2005. At December 31, 2007, our total pipeline of SFR mortgage loans in process was $7.5 billion, down 37% from $11.8 billion at December 31, 2006, and down 28% from $10.5 billion at December 31, 2005. On February 15, 2008, the MBA issued an estimate of the industry volume for 2007 of $2,332 billion, which represents a 14% drop from 2006, and a 23% drop from 2005. Based on this estimate, our market share is 3.30% for the year ended December 31, 2007 and remained flat compared to the year ended December 31, 2006, but up from 2.01% for the year ended December 31, 2005.
 
The decline in our SFR mortgage loan production from 2006 was attributable to the overall drop in industry mortgage origination volumes and from our transition to becoming primarily a GSE lender as a result of the severe disruption in housing and credit markets. Total SFR mortgage loan production decreased primarily due to the $14.0 billion decrease in our conduit business and the discontinuance of various products due to credit and liquidity concerns. We exited the conduit channel as a response to the disruption in the secondary market. Excluding production from the conduit channel, total SFR production increased $1.0 billion year-over-year. MPG’s mortgage broker and banker channel declined $1.7 billion in production from 2006. Our retail channel generated $2.0 billion in production for 2007. The Financial Freedom division saw a 6% decline in its reverse mortgage production from 2006 as competition intensified in the reverse mortgage market.


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The following summarizes our loan production by division and channel for the years indicated (dollars in millions):
 
                                         
    Year Ended December 31  
                % Change
          % Change
 
    2007     2006     2007/2006     2005     2007/2005  
 
Production by Division:
                                       
SFR mortgage loan production:
                                       
Mortgage professionals group:
                                       
Mortgage broker and banker channel(1)
  $ 45,449     $ 47,123       (4 )%   $ 34,864       30 %
Retail channel
    2,027       7       N/M             N/A  
Consumer direct division
    1,063       1,951       (46 )%     2,883       (63 )%
Financial Freedom division
    4,723       5,024       (6 )%     2,935       61 %
Servicing retention division
    4,593       2,698       70 %     1,079       326 %
Consumer construction division(2)
    2,988       2,937       2 %     2,994        
                                         
Total on-going businesses
    60,843       59,740       2 %     44,755       36 %
                                         
Conduit channel
    16,097       30,101       (47 )%     15,811       2 %
Home equity division(2)
    39       110       (65 )%     208       (81 )%
                                         
Total discontinued business activities
    16,136       30,211       (47 )%     16,019       1 %
                                         
Total SFR mortgage loan production
    76,979       89,951       (14 )%     60,774       27 %
Commercial loan production:
                                       
Commercial mortgage banking division — on-going businesses
    361             N/A             N/A  
Homebuilder division(2) — discontinued business activities
    976       1,747       (44 )%     1,940       (50 )%
                                         
Total loan production
  $ 78,316     $ 91,698       (15 )%   $ 62,714       25 %
                                         
Total pipeline of SFR mortgage loans in process at year end
  $ 7,506     $ 11,821       (37 )%   $ 10,488       (28 )%
                                         
 
 
(1) The mortgage broker and banker channel includes $5.3 billion, $3.3 billion and $1.3 billion of production from wholesale inside sales for 2007, 2006 and 2005, respectively. The mortgage broker and banker inside sales force focuses on small and geographically remote mortgage brokers through centralized in-house sales personnel instead of field sales personnel.
 
(2) The amounts of HELOCs, consumer construction loans and builder construction loans originated by these channels represent commitments.


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The following summarizes our loan production by product type for the years indicated (dollars in millions):
 
                                                 
    Year Ended December 31        
                % Change
          % Change
       
    2007     2006     2007/2006     2005     2007/2005        
 
Production by Product Type:
                                               
Standard first mortgage products:
                                               
Prime(1)
  $ 62,917     $ 71,403       (12 )%   $ 48,315       30 %        
Subprime(1)
    2,617       2,674       (2 )%     2,276       15 %        
                                                 
Total standard first mortgage products (S&P evaluated)
    65,534       74,077       (12 )%     50,591       30 %        
Specialty consumer home mortgage products:
                                               
HELOCs(1)/Seconds
    3,496       7,199       (51 )%     3,653       (4 )%        
Reverse mortgages
    4,723       5,024       (6 )%     2,935       61 %        
Consumer construction(2)
    3,182       3,651       (13 )%     3,595       (11 )%        
Government — FHA/VA(3)
    44             N/A             N/A          
                                                 
Subtotal SFR mortgage production
    76,979       89,951       (14 )%     60,774       27 %        
                                                 
Commercial loan products:
                                               
Commercial real estate
    361             N/A             N/A          
Builder construction commitments(2)
    976       1,747       (44 )%     1,940       (50 )%        
                                                 
Total production
  $ 78,316     $ 91,698       (15 )%   $ 62,714       25 %        
                                                 
Total S&P lifetime loss estimate(4)
    1.14 %     1.90 %             1.49 %                
                                                 
 
 
(1) The loan production by product type provides a breakdown of standard first mortgage products by prime and subprime only. As the definition of various product types tends to vary widely in the mortgage industry, we believe further classification may not accurately reflect the credit quality of loans produced implied through such classification.
 
(2) Amounts represent total commitments.
 
(3) Amounts represent loans insured by the Federal Housing Administration (“FHA”) and loans guaranteed by the Veterans Administration (“VA”).
 
(4) While our production is evaluated using the Standard & Poor’s (“S&P”) Levels model, the data are not audited or endorsed by S&P. S&P evaluated production excludes second liens, HELOCs, reverse mortgages, and construction loans. All loss estimates reported here have been restated to use S&P’s new 6.1 model which was released in November 2007.


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Loan Sale and Distribution
 
The following shows the various channels through which loans were distributed for the Company during the years indicated (dollars in millions):
 
                         
    Year Ended December 31  
    2007     2006     2005  
 
Distribution of Loans by Channel:
                       
Sales of GSE equivalent loans
    48 %     20 %     17 %
Private-label securitizations
    34 %     40 %     60 %
Whole loan sales, servicing retained
    17 %     38 %     20 %
Whole loan sales, servicing released
    1 %     2 %     3 %
                         
Total loan sales percentage
    100 %     100 %     100 %
                         
Total loan sales
  $ 71,164     $ 79,049     $ 52,297  
                         
 
Due to the disruptions in the secondary mortgage market, we have tightened our guidelines and focused on GSE eligible mortgage products. As a result, sales to GSEs increased to 48% of total loan distribution for the year ended December 31, 2007, up from 20% for the year ended December 31, 2006. We expect that a very high percentage of our loan sales will be to the GSEs until the private MBS market recovers.
 
In conjunction with the sale of mortgage loans, we generally retain certain assets. The primary assets retained include MSRs and, to a lesser degree, AAA-rated and agency interest-only securities, AAA-rated principal-only securities, prepayment penalty securities, late fee securities, investment and non-investment grade securities, and residual securities. The allocated cost of the retained assets at the time of sale is recorded as an asset with an offsetting increase to the gain on sale of loans (or a reduction in the cost basis of the loans sold). During the year ended December 31, 2007, the calculation of gain (loss) on sales of loans included the retention of $988.2 million of MSRs and $2.8 billion of other retained assets, consisting of investment-grade securities of $581.4 million and non-investment grade and residual securities of $169.0 million. During the year ended December 31, 2007, assets previously retained generated cash flows of $858.5 million. For more information on the valuation assumptions related to our retained assets, see “Table 12. Valuation of MSRs, Interest-Only, Prepayment Penalty, and Residual Securities” of “Appendix A: Additional Quantitative Disclosures.”
 
The profitability of our loans is measured by the MBR margin, which is calculated using mortgage banking revenue divided by total loans sold. MBR includes total consolidated gain (loss) on sale of loans and the net interest income earned on mortgage loans held for sale by mortgage banking production divisions. Most of the gain (loss) on sale of loans resulted from the loan sale activities in our mortgage banking segment. The gain (loss) on sale recognized in the thrift segment is included in the MBR margin calculation.
 
The following summarizes the amount of loans sold and the MBR margin during the years indicated (dollars in millions):
 
                                         
    Year Ended December 31  
                % Change
          % Change
 
    2007     2006     2007/2006     2005     2007/2005  
 
Total loans sold
  $ 71,164     $ 79,049       (10 )%   $ 52,297       36 %
MBR margin after production hedging
    0.99 %     1.41 %     (30 )%     1.70 %     (42 )%
MBR margin after credit costs
          1.28 %           1.62 %      
Net MBR margin
    (0.22 )%     1.06 %     (121 )%     1.37 %     (116 )%
 
For more details on our MBR margin, see “Table 7. MBR Margin” of “Appendix A: Additional Quantitative Disclosures.”


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MORTGAGE SERVICING DIVISION
 
Servicing is a key component of our business model, as it is a natural complement to our mortgage production operations and its financial performance tends to run countercyclical to the mortgage production business. Our mortgage servicing platform remains a strong and stable source of profitability in the midst of the current mortgage market turmoil.
 
Through MSRs retained from our mortgage banking activities, we collect fees and ancillary revenues for servicing loans sold into the secondary market. As interest rates rise and/or mortgage spreads widen, the expected life of the underlying loans is generally extended, which extends the life of the income stream flowing from those loans. This in turn increases the capitalized value of the associated MSRs. Conversely, as interest rates decline and/or mortgage spreads tighten, the value of the MSRs may also decline. To mitigate the potential volatility in the MSRs, we hedge this asset to earn a stable return throughout the interest rate cycle. For more information on servicing hedges, see the “Consolidated Risk Management Discussion” section.
 
During 2007, our MSRs experienced a decline in value due to significantly lower mortgage interest rates. However, this was more than offset by gains in value in our hedging instruments and from a continued decline in actual prepayment speeds in the year. Actual prepayment speeds have declined due to the impact of tighter guidelines on available mortgage loans in the market and declining home prices limiting the refinance capability of consumers.
 
Our servicing portfolio provides opportunities to cross sell other products, such as checking accounts, certificates of deposit, and other deposit services. In a declining interest rate environment, our servicing portfolio provides an existing base of customers who may be in the market to refinance. Capturing or “retaining” these customers helps mitigate the decline in the value of our mortgage servicing asset caused by prepayment of the original loan.
 
The fair value of our MSRs is determined using discounted cash flow techniques benchmarked against a third-party opinion of value. Estimates of fair value involve several assumptions, including assumptions about future prepayment rates, market expectations of future interest rates, cost to service the loans (including default management costs), ancillary incomes, and discount rates. Prepayment speeds are projected using a prepayment model developed by a third-party vendor and calibrated for the Company’s collateral. The model considers key factors, such as refinance incentive, housing turnover, seasonality, and aging of the pool of loans. Prepayment speeds incorporate expectations of future rates implied by the market forward LIBOR/swap curve, as well as collateral specific current coupon information. For further detail on the valuation assumptions, see “Table 12. Valuation of MSRs, Interest-Only, Prepayment Penalty, and Residual Securities” of “Appendix A: Additional Quantitative Disclosures.”
 
Total capitalized MSRs reached $2.5 billion as of December 31, 2007, up $673.0 million, or 37%, from $1.8 billion at December 31, 2006.


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The following provides additional details on the results for the mortgage servicing division for the years indicated (dollars in thousands):
 
                         
    Mortgage
          Total
 
    Servicing
    Servicing
    Mortgage
 
    Rights
    Retention
    Servicing
 
    Channel     Channel     Division  
 
Year Ended December 31, 2007
                       
Operating Results
                       
Net interest income (expense)
  $ (52,008 )   $ 11,445     $ (40,563 )
Provision for loan losses
                 
Gain (loss) on sale of loans
    2,241       53,883       56,124  
Service fee income
    389,441             389,441  
Gain (loss) on securities
    (35,595 )           (35,595 )
Other income
    6,042       6,944       12,986  
                         
Net revenues (expense)
    310,121       72,272       382,393  
Operating expenses
    48,390       48,683       97,073  
Deferral of expenses under SFAS 91
          (13,619 )     (13,619 )
                         
Pre-tax earnings (loss)
    261,731       37,208       298,939  
                         
Minority interests
    562       65       627  
                         
Net earnings (loss)
  $ 158,833     $ 22,594     $ 181,427  
                         
Performance Data
                       
Average interest-earning assets
  $ 343,595     $ 833,116     $ 1,176,711  
Allocated capital
    324,001       37,404       361,405  
Loans produced
          4,592,979       4,592,979  
Loans sold
          4,071,678       4,071,678  
MBR Margin
    N/A       1.32 %     1.38 %
ROE
    49 %     60 %     50 %
Net interest margin
    N/A       1.37 %     N/A  
Average FTE
    91       190       281  
                         
Year Ended December 31, 2006
                       
Operating Results
                       
Net interest income (expense)
  $ (16,277 )   $ 4,788     $ (11,489 )
Provision for loan losses
                 
Gain (loss) on sale of loans
    1,994       29,099       31,093  
Service fee income
    115,657       (8 )     115,649  
Gain (loss) on securities
    19,173             19,173  
Other income
    1,755       5,260       7,015  
                         
Net revenues (expense)
    122,302       39,139       161,441  
Operating expenses
    31,529       29,365       60,894  
Deferral of expenses under SFAS 91
          (8,068 )     (8,068 )
                         
Pre-tax earnings (loss)
    90,773       17,842       108,615  
                         
Net earnings (loss)
  $ 55,281     $ 10,866     $ 66,147  
                         
Performance Data
                       
Average interest-earning assets
  $ 242,837     $ 338,952     $ 581,789  
Allocated capital
    236,770       16,465       253,235  
Loans produced
          2,698,332       2,698,332  
Loans sold
    29,961       2,025,944       2,055,905  
MBR Margin
    N/A       1.44 %     1.51 %
ROE
    23 %     66 %     26 %
Net interest margin
    N/A       N/A       N/A  
Average FTE
    88       113       201  
                         
Year over Year Comparison
                       
% change in net earnings
    187 %     108 %     174 %
% change in capital
    37 %     127 %     43 %
 
SFR mortgage loans serviced for others reached $181.7 billion (including reverse mortgages and HELOCs) at December 31, 2007, with a weighted average coupon of 6.89%. In comparison, we serviced $139.8 billion of mortgage loans owned by others at December 31, 2006, with a weighted average coupon of 7.05%.


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The following provides the activity in the servicing portfolio for the years indicated (dollars in millions):
 
                 
    Year Ended December 31  
    2007     2006  
 
Unpaid principal balance at beginning of year
  $ 139,817     $ 84,495  
Additions
    72,613       80,237  
Clean-up calls exercised
    (153 )     (31 )
Loan payments and prepayments
    (30,553 )     (24,884 )
                 
Unpaid principal balance at end of year
  $ 181,724     $ 139,817  
                 
 
The following provides additional information related to the servicing portfolio as of the dates indicated:
 
                 
    December 31  
    2007     2006  
 
By Product Type:
               
Fixed rate mortgages
    36 %     35 %
Intermediate term fixed-rate loans
    35 %     30 %
Pay option ARMs
    17 %     23 %
Reverse mortgages
    10 %     9 %
HELOCs
    1 %     2 %
Other
    1 %     1 %
                 
Total
    100 %     100 %
                 
Additional Information(1)
               
Weighted average FICO(2)
    702       703  
Weighted average original LTV(3)
    73 %     73 %
Average original loan size (in thousands)
    247       232  
Percent of portfolio with prepayment penalty
    33 %     42 %
Portfolio delinquency (% of unpaid principal balance)(4)
    7.31 %     5.02 %
By Geographic Distribution:
               
California
    43 %     43 %
Florida
    8 %     8 %
New York
    8 %     8 %
New Jersey
    4 %     4 %
Virginia
    4 %     4 %
Other
    33 %     33 %
                 
Total
    100 %     100 %
                 
 
 
(1) Portfolio delinquency is calculated for the entire servicing portfolio. All other information presented excludes reverse mortgages.
 
(2) FICO scores are the result of a credit scoring system developed by Fair Isaacs and Co. and are generally used by lenders to evaluate a borrower’s credit history. FICO scores of 700 or higher are generally considered in the mortgage industry to be very high quality borrowers with low risk of default, but in general, the secondary market will consider FICO scores of 620 or higher to be prime.
 
(3) Combined loan-to-value (“LTV”) ratio for loans in the second lien position is used to calculate weighted average original LTV ratio for the portfolio.
 
(4) Delinquency is defined as 30 days or more past the due date excluding loans in foreclosure.


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THRIFT SEGMENT
 
Our thrift segment invests in loans originated by our various production units as well as in MBS. We manage our investments in the thrift portfolio based on the extent to which the ROEs exceed the cost of both core and risk-based capital, or they are needed to support the core mortgage banking investments in mortgage servicing rights and residual and non-investment grade securities, if the ROEs are below our cost of capital. Additionally, the segment engages in consumer construction lending. These investing activities provide core spread income and generally, a more stable return on equity.
 
In addition to the $33.0 million net earnings in our mortgage banking segment, our thrift segment reported a $199.2 million net loss in 2007 that was also caused by a large increase in credit related costs. Credit related costs for the thrift segment are reflected in the provision for loan losses as well as the valuation of our investment grade, non-investment grade and residual securities. Credit costs in the thrift segment for the year ended December 31, 2007 totaled $748 million pre-tax compared with only $28 million in credit costs in the thrift segment for the year ended December 31, 2006, as the provision for loan losses was offset by credit related valuation gain on residual securities. Although all the divisions in the thrift segment incurred higher credit costs in 2007, the majority of the increase was concentrated in the non-investment grade and residual securities divisions.


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Table of Contents

The following provides details on the results for divisions of our thrift segment for the years indicated (dollars in thousands):
 
                                                         
          Non-
                               
          Investment
    Total
                         
    Investment
    Grade and
    Mortgage-
    SFR
                   
    Grade
    Residual
    Backed
    Mortgage
    Consumer
    Warehouse
    Total
 
    Securities
    Securities
    Securities
    Loans HFI
    Construction
    Lending
    Thrift
 
    Channel     Channel     Division     Division     Division     Division     Segment  
 
Year Ended December 31, 2007
                                                       
Operating Results
                                                       
Net interest income
  $ 37,723     $ 57,033     $ 94,756     $ 78,201     $ 56,715     $ 5,193     $ 234,865  
Provision for loan losses
                      (145,364 )     (40,256 )     (299 )     (185,919 )
Gain (loss) on sale of loans
                      (7,225 )     31,634             24,409  
Service fee income (expense)
                                         
Gain (loss) on securities
    (53,206 )     (284,175 )     (337,381 )           (1,629 )           (339,010 )
Gain on sale and leaseback of building
                                         
Other income (expense)
    613       (3 )     610       2,065       24,660       2,014       29,349  
                                                         
Net revenues (expense)
    (14,870 )     (227,145 )     (242,015 )     (72,323 )     71,124       6,908       (236,306 )
Operating expenses
    1,023       2,771       3,794       23,091       66,547       3,698       97,130  
Severance charges
                                         
Deferral of expenses under SFAS 91
                            (8,251 )           (8,251 )
                                                         
Pre-tax earnings (loss)
    (15,893 )     (229,916 )     (245,809 )     (95,414 )     12,828       3,210       (325,185 )
                                                         
Minority interests
    176       324       500       492       208       7       1,207  
                                                         
Net earnings (loss)
  $ (9,855 )   $ (140,343 )   $ (150,198 )   $ (58,600 )   $ 7,604     $ 1,947     $ (199,247 )
                                                         
Performance Data
                                                       
Average interest-earning assets
  $ 4,850,600     $ 346,845     $ 5,197,445     $ 6,782,388     $ 2,802,416     $ 194,286     $ 14,976,535  
Allocated capital
    88,879       191,489       280,368       239,633       135,035       15,440       670,476  
Loans produced
                            2,988,322             2,988,322  
Loans sold
                      3,735,736       2,627,267             6,363,003  
ROE
    (11 )%     (73 )%     (54 )%     (24 )%     6 %     13 %     (30 )%
Net interest margin, thrift. 
    0.78 %     16.44 %     1.82 %     1.15 %     2.02 %     2.67 %     1.57 %
Efficiency ratio
    (7 )%     (1 )%     (2 )%     32 %     52 %     51 %     (176 )%
Average FTE
    3       8       11       12       384       29       436  
                                                         
Year Ended December 31, 2006
                                                       
Operating Results
                                                       
Net interest income
  $ 35,158     $ 37,059     $ 72,217     $ 76,081     $ 45,546     $ 3,489     $ 197,333  
Provision for loan losses
                      (9,225 )     (3,322 )     (181 )     (12,728 )
Gain (loss) on sale of loans
    (122 )           (122 )     3,703       39,068             42,649  
Service fee income (expense)
                                         
Gain (loss) on securities
    (1,359 )     3,750       2,391       384       659             3,434  
Other income (expense)
    (3 )           (3 )     1,637       23,412       1,725       26,771  
                                                         
Net revenues (expense)
    33,674       40,809       74,483       72,580       105,363       5,033       257,459  
Operating expenses
    1,131       2,418       3,549       4,978       69,073       4,120       81,720  
Deferral of expenses under SFAS 91
                            (8,812 )           (8,812 )
                                                         
Pre-tax earnings (loss)
    32,543       38,391       70,934       67,602       45,102       913       184,551  
                                                         
Net earnings (loss)
  $ 19,819     $ 23,380     $ 43,199     $ 41,170     $ 27,468     $ 557     $ 112,394  
                                                         
Performance Data
                                                       
Average interest-earning assets
  $ 3,329,118     $ 210,352     $ 3,539,470     $ 5,876,399     $ 2,502,397     $ 119,043     $ 12,037,309  
Allocated capital
    65,735       109,616       175,351       227,937       123,273       10,382       536,943  
Loans produced
                            2,937,596             2,937,596  
Loans sold
                      170,296       2,496,314             2,666,610  
ROE
    30 %     21 %     25 %     18 %     22 %     5 %     21 %
Net interest margin, thrift. 
    1.06 %     17.62 %     2.04 %     1.29 %     1.82 %     2.93 %     1.64 %
Efficiency ratio
    3 %     6 %     5 %     6 %     55 %     79 %     27 %
Average FTE
    5       7       12       13       422       26       473  
                                                         
Year over Year Comparison
                                                       
% change in net earnings
    (150 )%     N/M       (448 )%     (242 )%     (72 )%     250 %     (277 )%
% change in capital
    35 %     75 %     60 %     5 %     10 %     49 %     25 %


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The following tables and discussions present supplemental information to help understand the composition and credit quality of the assets held in our thrift portfolios. This section refers to company-wide assets, a small portion of which may be held in our mortgage banking segment.
 
MORTGAGE-BACKED SECURITIES DIVISION
 
The following provides the details of the MBS portfolio as of the dates indicated (dollars in thousands):
 
                                                                         
    December 31, 2007     December 31, 2006     December 31, 2005  
    Trading     AFS     Total     Trading     AFS     Total     Trading     AFS     Total  
 
Mortgage banking segment:
                                                                       
AAA-rated agency securities
  $     $     $     $     $ 2,915     $ 2,915     $     $     $  
AAA-rated and agency interest-only securities
    59,844             59,844       66,581             66,581       73,430             73,430  
AAA-rated principal-only securities
    88,024             88,024       38,478             38,478       9,483             9,483  
Prepayment penalty and late fee securities
    79,678             79,678       93,176             93,176       73,443             73,443  
                                                                         
Total mortgage banking
    227,546             227,546       198,235       2,915       201,150       156,356             156,356  
                                                                         
Thrift segment:
                                                                       
AAA-rated non-agency securities
    510,371       5,543,306       6,053,677       43,957       4,604,489       4,648,446       52,633       3,524,952       3,577,585  
AAA-rated agency securities
          45,296       45,296             62,260       62,260             43,014       43,014  
AAA-rated and agency interest-only securities
                      6,989             6,989       5,301             5,301  
Prepayment penalty and other securities
    2,349             2,349       4,400             4,400       2,298             2,298  
Other investment grade securities
    275,691       451,798       727,489       29,015       160,238       189,253       8,829       83,291       92,120  
Other non-investment grade securities
    93,859       61,889       155,748       41,390       38,784       80,174       4,480       53,232       57,712  
Non-investment grade residual securities
    112,727       3,687       116,414       218,745       31,828       250,573       119,065       48,706       167,771  
                                                                         
Total thrift 
    994,997       6,105,976       7,100,973       344,496       4,897,599       5,242,095       192,606       3,753,195       3,945,801  
                                                                         
Total mortgage-backed securities
  $ 1,222,543     $ 6,105,976     $ 7,328,519     $ 542,731     $ 4,900,514     $ 5,443,245     $ 348,962     $ 3,753,195     $ 4,102,157  
                                                                         
 
AAA-rated MBS represented 85%, 89% and 90% of the total portfolio at December 31, 2007, 2006 and 2005, respectively. These securities had an expected weighted average life of 3.0 years, 2.9 years and 2.6 years at December 31, 2007, 2006 and 2005, respectively. Due to downgrades of investment grade securities in January 2008, we anticipate an increase in non-investment grade securities.
 
In 2007, the Bank securitized $24.0 billion of mortgage loans. The Bank retained $2.8 billion of the securities and sold $21.2 billion. Of the $2.8 billion retained securities recorded as MBS, $2.2 billion and $0.6 billion were classified as available for sale and trading, respectively.
 
SFR MORTGAGE LOANS HFI DIVISION
 
The SFR mortgage HFI portfolio is comprised primarily of interest-only loans and adjustable-rate mortgage loans.
 
At December 31, 2007, we had $3.0 billion in pay option ARM loans, or 26% of the portfolio, as compared to $1.2 billion, or 18% of the portfolio, at December 31, 2006. As of December 31, 2007, approximately 91% (based on loan count) of our pay option ARM loans had negatively amortized, resulting in an increase of $102.3 million to their original loan balance. This is an increase from 83% at December 31, 2006. The net increase in unpaid principal


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balance due to negative amortization was $75.5 million for the year ended December 31, 2007, which approximated the deferred interest recognized for the years.
 
We transferred HFS mortgage loans in the fourth quarter of 2007 with an original cost basis of $10.9 billion to HFI as we no longer intend to sell these loans given the extreme disruption in the secondary mortgage market. These loans were transferred at LOCOM and, accordingly, we reduced the cost basis by $0.6 billion resulting in an increase in HFI loans of $10.3 billion. The $0.6 billion reduction was a combination of LOCOM reserves existing in the third quarter of 2007 and additional charges to gain on sale of loans during the fourth quarter of 2007. Embedded in this reduction are estimated credit losses of $474 million. During the year, the Bank securitized $24.0 billion, of which $2.0 billion of mortgage loans came from the SFR mortgage loans HFI division.
 
The following provides a composition of the SFR mortgage loans HFI portfolio and the relevant credit quality characteristics as of the dates indicated (dollars in thousands):
 
                 
    December 31  
    2007     2006  
 
Outstanding balance (recorded value)(1)
  $ 11,411,464     $ 6,519,340  
Average loan size
  $ 270     $ 310  
Non-performing loans
    6.47 %     1.09 %
Estimated average life in years(2)
    2.4       2.6  
Estimated average net duration in months(3)
    2.1       (3.5 )
Annualized yield
    7.03 %     6.01 %
Percent of loans with active prepayment penalty
    43 %     34 %
By Product Type:
               
Fixed-rate mortgages
    15 %     5 %
Intermediate term fixed-rate loans
    15 %     15 %
Interest-only loans
    43 %     60 %
Pay option ARMs
    26 %     18 %
Other
    1 %     2 %
                 
      100 %     100 %
Additional Information:
               
Average FICO score
    693       716  
Original average LTV
    76 %     73 %
Current average LTV(4)
    77 %     61 %
Geographic distribution of top five states:
               
Southern California
    30 %     32 %
Northern California
    15 %     20 %
                 
Total California
    45 %     52 %
Florida
    9 %     6 %
New York
    7 %     4 %
New Jersey
    3 %     2 %
Maryland
    3 %     2 %
Other
    33 %     34 %
                 
Total
    100 %     100 %
                 
 
 
(1) The outstanding balance at December 31, 2007 includes $286.3 million of lot loans.
 
(2) Represents the estimated length of time, on average, the SFR loan portfolio will remain outstanding based on our estimates for prepayments.
 
(3) Average net duration measures the expected change in the value of a financial instrument in response to changes in interest rates, taking into consideration the impact of the related hedges. The negative net duration implies an increase in value as rates rise while the positive net duration implies a decrease in value.
 
(4) Current average LTV ratio is estimated based on the Office of the Federal Housing Enterprise Oversight House Price Index Metropolitan Statistical Area data for the year ended December 31, 2007 on a loan level basis.


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CONSUMER CONSTRUCTION DIVISION
 
Our consumer construction division provided construction financing for individual consumers who want to build a new primary residence or second home. The primary product is a construction-to-permanent (“CTP”) residential mortgage loan. This product typically provides financing for a construction term from 6 to 12 months and automatically converts to a permanent mortgage loan at the end of construction. The end result is a loan product that represents a hybrid activity between our portfolio lending and mortgage banking activities. As of December 31, 2007, based on the underlying note agreements, 80% of the construction loans will be converted to adjustable-rate permanent loans, 13% to intermediate term fixed-rate loans, and 7% to fixed-rate loans.
 
The consumer construction division temporarily suspended all new CTP production on January 31, 2008 to help manage our balance sheet. Our consumer construction division had previously suspended lot and single spec production in 2007.
 
During 2007, we entered into new consumer construction commitments of $3.2 billion, which is a decrease of 13%, or $470 million from 2006. Approximately 68% of new commitments are generated through mortgage broker customers of the MPG, and the remaining 32% of new commitments are retail originations. Consumer construction loans outstanding at December 31, 2007 increased 3% from December 31, 2006.
 
Since the introduction of a monthly adjusting construction period ARM product in the second quarter of 2006, the percentage of adjustable-rate loans in our portfolio has increased to 72% at December 31, 2007 from 29% at December 31, 2006. The ratio of non-performing loans increased to 3.31% of the portfolio at December 31, 2007, compared to 1.14% at December 31, 2006. As a result, we increased the allowance for loan losses to $32.3 million for the year ended December 31, 2007 from $11.8 million for the year ended December 31, 2006 and increased the percentage of allowance for loan losses to recorded value to 1.38% at the end of 2007 from 0.52% at the end of 2006.


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Information on our consumer construction portfolio is presented in the following table as of the dates indicated (dollars in thousands):
 
                                 
    December 31              
    2007     2006              
 
Outstanding balance (recorded value)
  $ 2,343,094     $ 2,276,133                  
Total commitments
    3,503,790       3,600,454                  
Average loan commitment(1)
    570       474                  
Non-performing loans
    3.31 %     1.14 %                
By Product Type:
                               
Fixed-rate loans
    28 %     71 %                
Adjustable-rate loans
    72 %     29 %                
                                 
      100 %     100 %                
                                 
Additional Information:
                               
Average LTV ratio(2)
    73 %     73 %                
Average FICO score
    722       718                  
Geographic distribution of top five states:
                               
Southern California
    30 %     28 %                
Northern California
    12 %     15 %                
                                 
Total California
    42 %     43 %                
Florida
    7 %     9 %                
Washington
    4 %     4 %                
New York
    4 %     4 %                
Arizona
    4 %     3 %                
Other
    39 %     37 %                
                                 
Total
    100 %     100 %                
                                 
 
 
(1) In March 2007, estate lending was introduced for loans on commitments greater than $2.5 million. We originated approximately $306 million or 96 loans in 2007 for an average loan size of $3.2 million which contributed to the increase in loan size during the year.
 
(2) The average LTV ratio is based on the most recent estimated appraised value of the completed project compared to the commitment amount at the date indicated.
 
The following provides details on the aggregate maturities of construction loan balances due at December 31, 2007 (dollars in thousands):
 
                 
Within one year or less
  $ 2,229,491          
Between one to five years (98% adjustable-rate and 2% fixed-rate)
    112,569          
                 
Total
  $ 2,342,060          
                 
 
ELIMINATIONS & OTHER SEGMENT
 
This segment contains the fixed costs of our deposit raising and treasury functions that are not allocated to our operating divisions, as well as entries to eliminate the impact of transactions between segments. In addition to selling loans into the secondary market, our mortgage production division regularly sells loans to our SFR mortgage loans HFI division. These transactions are recorded at arms-length in our segment results resulting in intercompany gain on sale in the mortgage production division and a premium in the SFR mortgage loans HFI division that is amortized over the life of the loan. Both the gain and the premium amortization are eliminated in consolidation.


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The mortgage production division and the mortgage servicing division are exposed to movements in the intermediate fixed-rate loan spreads. Mortgage spread is the difference between mortgage interest rates and LIBOR/interest rate swap rates. Tighter spreads benefit mortgage production as they lead to improved loan sales execution while wider spreads lead to slower projected prepayment speeds and an increase in the MSR value. Due to the inherent difficulty in hedging the movement of these spreads, the potential for an internal hedge exists whereby the risks from the spread movements will be shared between the two groups. Starting in the first quarter of 2007, the mortgage production division and the mortgage servicing division entered into an inter-divisional transaction to economically hedge their respective financial risks to mortgage spreads for certain products in the absence of readily available derivative instruments. With all else remaining constant, when mortgage spreads widen, the pipeline of mortgage loans held for sale is negatively impacted and mortgage servicing is positively impacted. The impact of the hedges has been reflected in the respective channel results with the consolidation adjustment recorded under “Interdivision Hedge Transactions” within “Eliminations”.
 
The following provides additional details on deposits, treasury and eliminations for the years indicated (dollars in thousands):
 
                                                 
                Eliminations        
                      Interdivision
             
                Interdivision
    Hedge
             
    Deposits     Treasury     Loan Sales(1)     Transactions     Other     Total  
 
Year Ended December 31, 2007
                                               
Operating Results
                                               
Net interest income
  $     $ 45,072     $ 37,513     $     $ 25,352     $ 107,937  
Provision for loan losses
                                   
Gain (loss) on sale of loans
                (82,081 )     (84,921 )     (1,081 )     (168,083 )
Service fee income
                      84,921       3,436       88,357  
Gain (loss) on securities
                            (42,965 )     (42,965 )
Other income
    4,431       1,269                   (2,118 )     3,582  
                                                 
Net revenues (expense)
    4,431       46,341       (44,568 )           (17,376 )     (11,172 )
Operating expenses
    27,815       54,665                   (17,298 )     65,182  
Deferral of expenses under SFAS 91
                            (78 )     (78 )
                                                 
Pre-tax earnings (loss)
    (23,384 )     (8,324 )     (44,568 )                 (76,276 )
                                                 
Minority interests
    3       20,026                         20,029  
                                                 
Net earnings (loss)
  $ (14,244 )   $ (25,095 )   $ (26,458 )   $     $     $ (65,797 )
                                                 
Year Ended December 31, 2006
                                               
Operating Results
                                               
Net interest income
  $     $ 28,235     $ 32,275     $     $ 15,629     $ 76,139  
Provision for loan losses
                                   
Gain (loss) on sale of loans
                (67,639 )                 (67,639 )
Service fee income
                (4,361 )           (31,578 )     (35,939 )
Gain (loss) on securities
                10,809                   10,809  
Other income
    3,476       677                   (5,817 )     (1,664 )
                                                 
Net revenues (expense)
    3,476       28,912       (28,916 )           (21,766 )     (18,294 )
Operating expenses
    26,764       40,107                   (17,862 )     49,009  
Deferral of expenses under SFAS 91
                            (2,229 )     (2,229 )
                                                 
Pre-tax earnings (loss)
    (23,288 )     (11,195 )     (28,916 )           (1,675 )     (65,074 )
                                                 
Net earnings (loss)
  $ (14,182 )   $ (6,818 )   $ (17,610 )   $     $ 4,258     $ (34,352 )
                                                 
 
 
(1) Includes loans sold of $15.2 billion and $9.2 billion for the years ended December 31, 2007 and 2006, respectively.


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CORPORATE OVERHEAD SEGMENT
 
As previously mentioned, we do not allocate fixed corporate overhead costs to our profit center divisions, because the methodologies to do so are arbitrary and distort each division’s marginal contribution to our profits. These unallocated corporate overhead costs are reported in the corporate overhead segment. The after-tax loss from this segment increased from a loss of $106.7 million in 2006 to a loss of $101.6 million in 2007.
 
DISCONTINUED BUSINESS ACTIVITIES
 
As conditions in the U.S. mortgage market have deteriorated, we have exited certain production channels and are reporting them in a separate category in our segment reporting. These exited production channels include conduit, home equity and homebuilder. Of the $698.6 million in total credit costs we reported in 2007, $543.5 million were in these discontinued businesses, driving the total after-tax loss of $281.1 million for these discontinued businesses for the year. These activities are not considered discontinued operations as defined by SFAS 144 due to our significant continuing involvement in these activities.


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The following provides details on the results of our exited businesses for the years indicated (dollars in thousands):
 
                                                   
    Discontinued Business Activities    
            Home
                           
    Conduit
      Equity
      Homebuilder
                   
    Channel       Division       Division       Other       Total    
 
Year Ended December 31, 2007
                                                 
Operating Results
                                                 
Net interest income
  $ 63,658       $ 28,072       $ 46,602       $ 1,797       $ 140,129    
Provision for loan losses
            (29,960 )       (178,144 )       (1,525 )       (209,629 )  
Gain (loss) on sale of loans
    (205,207 )       (102,337 )                       (307,544 )  
Service fee income (expense)
            3,406                         3,406    
Gain on sale and leaseback of building
            (22,143 )                       (22,143 )  
Other income (expense)
    (316 )       6,295         (577 )               5,402    
                                         
Net revenues (expense)
    (141,865 )       (116,667 )       (132,119 )       272         (390,379 )  
Operating expenses
    37,667         15,461         23,539         245         76,912    
Severance charges
                                       
Deferral of expenses under SFAS 91
            (455 )       (5,950 )               (6,405 )  
                                         
Pre-tax earnings (loss)
    (179,532 )       (131,673 )       (149,708 )       27         (460,886 )  
                                         
Minority interests
    133         234         78         4         449    
                                         
Net earnings (loss)
  $ (109,468 )     $ (80,424 )     $ (91,250 )     $ 13       $ (281,129 )  
                                         
Performance Data
                                                 
Average interest-earning assets
  $ 4,517,142       $ 1,632,317       $ 1,222,646       $ 31,811       $ 7,403,916    
Allocated capital
    202,651         122,980         91,802         2,820         420,253    
Loans produced
    16,096,606         38,435         976,018                 17,111,059    
Loans sold
    19,836,221         1,010,436                         20,846,657    
MBR margin
    (0.71 ) %     N/A         N/A         N/A         (1.17 ) %
ROE
    (54 ) %     (65 ) %     (99 ) %             (67 ) %
Net interest margin
    1.41   %     1.72   %     3.81   %     5.65   %     1.89   %
Net interest margin, thrift
    N/A         N/A         N/A         N/A         N/A    
Efficiency ratio
    N/A         (17 ) %     38   %     14   %     (39 ) %
Average FTE
    135         79         121                 335    
                                                   
Year Ended December 31, 2006
                                                 
Operating Results
                                                 
Net interest income
  $ 79,138       $ 39,503       $ 60,422       $ 2,202       $ 181,265    
Provision for loan losses
            (1,800 )       (3,800 )       (1,665 )       (7,265 )  
Gain (loss) on sale of loans
    52,465         23,996                 (11 )       76,450    
Service fee income (expense)
            466                         466    
Gain (loss) on securities
            (12,934 )                       (12,934 )  
Other income (expense)
    (63 )       8,723         1,867                 10,527    
                                         
Net revenues (expense)
    131,540         57,954         58,489         526         248,509    
Operating expenses
    29,841         20,496         21,516         307         72,160    
Deferral of expenses under SFAS 91
            (1,165 )       (6,993 )               (8,158 )  
                                         
Pre-tax earnings (loss)
    101,699         38,623         43,966         219         184,507    
                                         
Net earnings (loss)
  $ 61,935       $ 23,523       $ 26,775       $ 134       $ 112,367    
                                         
Performance Data
                                                 
Average interest-earning assets
  $ 4,149,226       $ 1,934,429       $ 1,076,213       $ 40,627       $ 7,200,495    
Allocated capital
    182,133         148,033         104,123         3,584         437,873    
Loans produced
    30,102,134         109,375         1,746,690                 31,958,199    
Loans sold
    28,425,553         2,604,875                         31,030,428    
MBR margin
    0.46   %     N/A         N/A         N/A         N/A    
ROE
    34   %     16   %     26   %     4   %     26   %
Net interest margin
    1.91   %     2.04   %     5.61   %     5.42   %     2.52   %
Net interest margin, thrift
    N/A         N/A         N/A         N/A         N/A    
Efficiency ratio
    N/A         32   %     23   %     14   %     25   %
Average FTE
    147         75         108                 330    
                                                   
Year to Year Comparison
                                                 
% change in net earnings
    (277 ) %     (442 ) %     (441 ) %     (90 ) %     (350 ) %
% change in capital
    11   %     (17 ) %     (12 ) %     (21 ) %     (4 ) %
 
CONDUIT CHANNEL
 
The conduit channel purchased pools of closed loans for portfolio, resale, or securitization and this channel was characterized by its low cost operations and quick asset turn times. For the year ended December 31, 2007, our loan production from the conduit channel dropped 47% to $16.1 billion as compared to $30.1 billion for the year


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ended December 31, 2006. This decline in volume was attributable to the fact that we exited this channel due to its inherently lower profit margins and the current uncertainty with respect to secondary market spreads and execution. The conduit channel recorded a net loss of $109.5 million for the year ended December 31, 2007, down 277% from net earnings of $61.9 million for the year ended December 31, 2006.
 
HOME EQUITY DIVISION
 
The home equity division provided HELOC and closed-end second mortgages nationwide through our retail and mortgage broker and banker channels. We have ceased new originations in this division as a response to extreme disruptions in the housing and mortgage markets.
 
At December 31, 2007, our total HELOC servicing portfolio amounted to $4.2 billion, an increase of approximately $599.4 million from December 31, 2006. We produced $2.2 billion of new HELOC commitments through our mortgage banking segment and internal channels during 2007, sold $1.0 billion and realized a net loss on sale of $85.0 million primarily due to LOCOM adjustments of $100.0 million. During 2006, we produced $3.9 billion of HELOC loans and sold $2.6 billion with a corresponding net gain on sale of $24.6 million.
 
Our HELOC securitization agreements contain provisions that, under certain circumstances, the securitization enters a “rapid amortization period”. During this period, all new draws on revolving HELOC loans are allocated to a seller’s interest on our consolidated balance sheets. This causes the outstanding bonds to pay down quickly.
 
Our securitization agreements treat our seller’s interest as “pari passu” to the securitization trust. Accordingly, any cash received on the underlying loans is distributed on a pro-rata basis, and our seller’s interest is not subordinated to the securitization trust, even in rapid amortization. As of December 31, 2007, none of our securitizations were in a rapid amortization period. However, we believe one or more securitizations will enter rapid amortization in 2008. Since our seller’s interest is not subordinated, the expected impact on our financial statements is projected to be a small increase in HELOC loans outstanding, which will likely be offset by the run-off in the existing HFI portfolio.
 
All HELOC loans are adjustable-rate loans and indexed to the prime rate. Information on the combined HELOC portfolio, including both HFS and HFI loans, is presented as of the dates indicated (dollars in thousands):
 
                 
    December 31  
    2007     2006  
 
Outstanding balance (recorded value)
  $ 1,628,282     $ 656,714  
Total commitments(1)
    3,239,902       2,211,298  
Average spread over prime
    1.16 %     1.39 %
Average FICO score
    736       737  
Average combined LTV ratio(2)
    77 %     77 %


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Additional Information on HELOC Portfolio
 
                                         
          Average Loan
          Current
    30+ Days
 
December 31, 2007
  Outstanding
    Commitment
    Average Spread
    Average
    Delinquency
 
Combined LTV
  Balance     Balance     Over Prime     FICO     %(3)  
 
96% to 100%
  $ 70,936     $ 85       2.44 %     709       9.92 %
91% to 95%
    264,639       91       1.77 %     720       5.82 %
81% to 90%
    538,212       80       1.55 %     718       4.12 %
71% to 80%
    431,064       136       0.57 %     744       2.06 %
70% or less
    323,431       142       0.40 %     755       1.07 %
                                         
Total
  $ 1,628,282       108       1.16 %     736       3.50 %
                                         
                                         
                                         
          Average Loan
          Current
    30+ Days
 
December 31, 2006
  Outstanding
    Commitment
    Average Spread
    Average
    Delinquency
 
Combined LTV
  Balance     Balance     Over Prime     FICO     %(3)  
 
96% to 100%
  $ 87,718     $ 141       2.14 %     728       4.16 %
91% to 95%
    115,868       124       2.17 %     715       0.62 %
81% to 90%
    226,440       114       1.58 %     719       2.34 %
71% to 80%
    129,441       198       0.63 %     746       0.77 %
70% or less
    97,247       200       0.35 %     754       0.90 %
                                         
Total
  $ 656,714       156       1.39 %     737       1.76 %
                                         
 
 
(1) On funded loans.
 
(2) The combined LTV combines the LTV on both the first mortgage loan and the HELOC.
 
(3) 30+ days delinquency include loans that are 30 days or more past the due date including loans in foreclosure.
 
HOMEBUILDER DIVISION
 
The homebuilder division has ceased new originations in response to the extreme disruptions in the housing and mortgage markets. We do not anticipate being in this business once the current portfolio is worked out and paid off. We are monitoring this portfolio very closely, as the housing fundamentals are expected to continue to weaken, which affects both the underlying collateral values and the projected repayment sources for these loans. Accordingly, we expect to have additional downgrades, additional provisions for loan losses, and charge-offs relating to this portfolio.
 
The rapid deterioration in the California and Florida real estate markets and the disruption in the mortgage market nationwide that began in the third quarter of 2006 had a significant impact on our homebuilder borrowers and on our portfolio of loans. Classified assets were $675.3 million, or 56% of outstandings at December 31, 2007, up from $121.2 million or 11% of outstandings at December 31, 2006. At December 31, 2007, non-performing loans rose to $480.2 million, from $9.0 million at December 31, 2006. A loan is considered non-performing if the loan becomes delinquent in excess of 90 days from the due date or full payment of interest or principal is no longer anticipated. It can also be considered non-performing if the accrual of interest from the interest reserve will cause a loss.
 
There were 1,288 unsold units under construction or completed at December 31, 2007 compared to 1,254 unsold units at December 31, 2006. The weighted average LTV ratio of this portfolio increased to 82% at December 31, 2007 compared to 73% at December 31, 2006.
 
The increase in non-performing and classified assets resulted in a provision to the allowance for loan losses of $178.1 million for 2007, or 14.49% of average loans for the year, up from $3.8 million, or 0.35% of average loans for 2006. The total allowance for loan losses increased to $198.6 million, or 16.66% of recorded value of total loans, at December 31, 2007, up from $20.5 million or 1.79% of recorded value of total loans, at December 31, 2006.


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There were no charge-offs and REO in 2007, but we believe we will have charge-offs and REO in 2008 although we cannot predict at this time the extent of any future charge-offs or REO.
 
Information on our homebuilder portfolio is presented in the following table as of the dates indicated (dollars in thousands):
 
                 
    December 31  
    2007     2006  
 
Outstanding balance (recorded value)
  $ 1,192,093     $ 1,144,835  
Total commitments
    1,662,060       2,010,727  
Average loan commitments
    8,480       10,810  
Percentage of homes under construction or completed that are sold
    30 %     37 %
Non-performing loans
    40.28 %     0.78 %
Allowance for loan losses as a percentage of recorded value
    16.66 %     1.79 %
Additional Information:
               
Average LTV ratio(1)
    82 %     73 %
Geographic distribution of top five states:
               
Southern California
    37 %     41 %
Northern California
    29 %     19 %
                 
Total California
    66 %     60 %
Florida
    10 %     11 %
Illinois
    7 %     9 %
Oregon
    4 %     6 %
Arizona
    3 %     4 %
Other
    10 %     10 %
                 
Total
    100 %     100 %
                 
 
 
(1) The average LTV ratio is based on the most recent estimated appraised value of the completed project compared to the commitment amount at the date indicated.
 
The following provides details on the aggregate maturities of construction loan balances due at December 31, 2007 (dollars in thousands):
 
                         
Within one year or less
  $ 988,590                  
Between one to five years(1)
    202,964                  
More than five years
    539                  
                         
Total(2)
  $ 1,192,093                  
                         
 
 
(1) 71.5% of these loans are scheduled to mature in 2009 while the remaining loans are scheduled to mature through 2012.
 
(2) 100% of these construction loans have all floating rates.
 
CONSOLIDATED RISK MANAGEMENT DISCUSSION
 
We manage many types of risks with several layers of risk management and oversight, using both a centralized and decentralized approach. Our philosophy is to put risk management at the core of our operations and establish a unified framework for measuring and managing risk across the enterprise, providing our business units with the tools — and accountability — to manage risk. At the corporate level, this consolidated risk management is known as Enterprise Risk Management (“ERM”). ERM, in partnership with the Board of Directors and senior management, provide support to and oversight of the business units.


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ERM, as a part of management, develops, maintains and monitors our cost effective yet comprehensive enterprise-wide risk management framework, including our system of operating internal controls. ERM fosters a risk management culture throughout Indymac and exists to help us manage unexpected losses, earnings surprises and reputation damage. It also provides management and the Board with a better understanding of the trade-offs between risks and rewards, leading to smarter investment decisions and more consistent and generally higher long-term returns on equity.
 
CAMELS FRAMEWORK FOR RISK MANAGEMENT
 
The framework for organizing ERM is based on the six-point rating scale used by the OTS, our regulating body, to evaluate the financial condition of savings and loan associations. A discussion of the areas covered by CAMELS (Capital, Asset Quality, Management, Earnings, Liquidity and Sensitivity to Market Risk) follows.
 
CAPITAL
 
The Bank is subject to regulatory capital regulations administered by the federal banking agencies. As of December 31, 2007, Indymac Bank met all of the requirements of a “well-capitalized” institution under the general regulatory capital regulations. Refer to “Note 22 — Regulatory Requirements” in the accompanying notes to consolidated financial statements for further discussion.
 
Our business is primarily centered on single-family lending and the related production and sale of loans. Due to the disruption of the secondary markets, loan sales were adversely impacted, resulting in lower than normal volume. Thus, we significantly changed our production model and transitioned to primarily become a GSE lender.
 
The accumulation of MSRs is a large component of our strategy. As of December 31, 2007, the capitalized value of MSRs was $2.5 billion. OTS regulations effectively impose higher capital requirements on the amount of MSRs that exceeds total Tier 1 capital. These higher capital requirements could result in lowered returns on our retained assets and could limit our ability to retain servicing assets and even cause our capital levels to decline significantly if the value of our MSRs grows. While management believes that compliance with the capital limits on MSRs will not materially impact future results, no assurance can be given that our plans and strategies will be successful.
 
Capital Management and Allocation
 
As a federally regulated thrift, we are required to measure regulatory capital using two different methods: core capital and risk-based capital. Under the core capital method, a fixed percentage of capital is required against each dollar of assets without regard to the type of asset. Under the risk-based capital method, capital is held against assets which are adjusted for their relative credit risk using standard “risk weighting” percentages. We allocate capital using the regulatory minimums for well-capitalized institutions for each applicable asset class. The ratios are below the regulatory minimums due to the use of trust preferred securities as a form of regulatory capital.


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The following provides information on the core and risk-based capital ratios for the two segments and each of their operating divisions for the year ended December 31, 2007 (dollars in thousands):
 
                                                                                 
    Total Assets     Core     Risk-Based  
          % of
    Avg.
    % of
                Avg.
    % of
             
    Average
    Total
    Allocated
    Total
    Capital/
          Allocated
    Total
    Capital/
       
Year Ended December 31, 2007
  Assets     Assets     Capital     Capital     Assets     ROE     Capital     Capital     Assets     ROE  
 
Mortgage Banking Segment:
                                                                               
Consumer Direct Division
  $ 121,984       0.4 %   $ 4,800       0.2 %     3.9 %     (43 )%   $ 5,710       0.3 %     4.7 %     (35 )%
                                                                                 
Retail Channel
    187,865       0.5 %     6,972       0.4 %     3.7 %     (454 )%     13,761       0.7 %     7.3 %     (227 )%
Mortgage Broker and Banker Channel
    5,900,356       16.4 %     232,224       11.7 %     3.9 %     (51 )%     288,202       14.6 %     4.9 %     (40 )%
                                                                                 
Total Mortgage Professionals Group
    6,088,221       16.9 %     239,196       12.1 %     3.9 %     (63 )%     301,963       15.3 %     5.0 %     (49 )%
                                                                                 
Financial Freedom Division
    1,247,910       3.5 %     142,607       7.2 %     11.4 %     37 %     134,244       6.8 %     10.8 %     39 %
                                                                                 
Total Mortgage Production Division
    7,458,115       20.8 %     386,603       19.5 %     5.2 %     (26 )%     441,917       22.4 %     5.9 %     (22 )%
                                                                                 
Mortgage Servicing Rights Channel
    3,095,917       8.6 %     204,790       10.4 %     6.6 %     74 %     324,001       16.4 %     10.5 %     49 %
Servicing Retention Channel
    836,318       2.3 %     32,687       1.7 %     3.9 %     68 %     37,404       1.9 %     4.5 %     60 %
                                                                                 
Total Mortgage Servicing Division
    3,932,235       10.9 %     237,477       12.1 %     6.0 %     74 %     361,405       18.3 %     9.2 %     50 %
Mortgage Bank Overhead
    149,312       0.4 %     5,635       0.3 %     3.8 %     N/A       14,208       0.7 %     9.5 %     N/A  
                                                                                 
Total Consumer Mortgage Banking
    11,539,662       32.1 %     629,715       31.9 %     5.5 %     5 %     817,530       41.4 %     7.1 %     5 %
Commercial Mortgage Banking Division
    73,956       0.2 %     2,616       0.1 %     3.5 %     (295 )%     5,778       0.3 %     7.8 %     (130 )%
                                                                                 
Total Mortgage Banking Segment
    11,613,618       32.3 %     632,331       32.0 %     5.4 %     4 %     823,308       41.7 %     7.1 %     4 %
                                                                                 
Thrift Segment:
                                                                               
Investment grade securities
    4,876,783       13.6 %     192,983       9.8 %     4.0 %     (2 )%     88,879       4.5 %     1.8 %     (11 )%
Non-investment grade and residuals securities
    401,745       1.1 %     12,225       0.6 %     3.0 %     N/M       191,489       9.7 %     47.7 %     (73 )%
                                                                                 
Total Mortgage-Backed Securities
    5,278,528       14.7 %     205,208       10.4 %     3.9 %     (75 )%     280,368       14.2 %     5.3 %     (54 )%
SFR Mortgage Loans HFI Division
    6,799,552       18.9 %     266,148       13.5 %     3.9 %     (21 )%     239,633       12.1 %     3.5 %     (24 )%
Consumer Construction Division
    2,811,039       7.8 %     109,977       5.6 %     3.9 %     6 %     135,035       6.8 %     4.8 %     6 %
Warehouse Lending Division
    190,374       0.5 %     7,531       0.4 %     4.0 %     20 %     15,440       0.8 %     8.1 %     13 %
                                                                                 
Total Thrift Segment
    15,079,493       41.9 %     588,864       29.9 %     3.9 %     (35 )%     670,476       33.9 %     4.4 %     (30 )%
                                                                                 
Consumer Bank — Deposits
    51,727       0.1 %     2,031       0.1 %     3.9 %     N/A       4,325       0.2 %     8.4 %     N/A  
Treasury
                374,618       18.7 %     N/A       N/A                   N/A       N/A  
Eliminations
                            N/A       N/A                   N/A       N/A  
                                                                                 
Total Operating
    26,744,838       74.3 %     1,597,844       80.7 %     6.0 %     (13 )%     1,498,109       75.8 %     5.6 %     (15 )%
Corporate overhead
    1,773,748       4.9 %     86,171       4.4 %     4.9 %     N/A       58,570       3.0 %     3.3 %     N/A  
                                                                                 
Total On-Going Businesses
    28,518,586       79.2 %     1,684,015       85.1 %     5.9 %     (19 )%     1,556,679       78.8 %     5.5 %     (21 )%
                                                                                 
Discontinued Business Activities:
                                                                               
Conduit Channel
    4,566,315       12.7 %     181,077       9.2 %     4.0 %     (61 )%     202,651       10.3 %     4.4 %     (54 )%
Home Equity Division
    1,673,894       4.7 %     64,413       3.3 %     3.8 %     (130 )%     122,980       6.2 %     7.3 %     (65 )%
Homebuilder Division
    1,182,714       3.3 %     46,376       2.3 %     3.9 %     (202 )%     91,802       4.6 %     7.8 %     (99 )%
Other
    27,513       0.1 %     1,051       0.1 %     3.8 %     (8 )%     2,820       0.1 %     10.2 %      
                                                                                 
Total Discontinued Business Activities
    7,450,436       20.8 %     292,917       14.9 %     3.9 %     (98 )%     420,253       21.2 %     5.6 %     (67 )%
                                                                                 
Total Company
  $ 35,969,022       100.0 %   $ 1,976,932       100.0 %     5.5 %     (31 )%   $ 1,976,932       100.0 %     5.5 %     (31 )%
                                                                                 
 
As the table shows, certain asset types require more or less capital depending on the capital measurement method. For example, non-investment grade and residual securities are allocated 3.0% core capital and 47.7% risk-based capital. These differing methods result in significantly different ROEs as shown. We attempt to manage our business segments and balance sheet to optimize capital efficiency under both capital methods.


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ASSET QUALITY
 
Indymac uses both a centralized and a decentralized approach to credit risk management. At the corporate level, ERM oversees the development of a framework (through people, policies and processes) for credit risk management the business unit leaders use to document and “matrix manage” their credit and fraud risk. This framework includes the establishment and enforcement of strong corporate credit governance to maintain investment, lending and fraud policies that are simple, but highly effective. Each business unit has its own chief credit officer to oversee and implement these procedures. By tracking historical credit losses and factors contributing to the losses, we continuously implement changes to significantly reduce the likelihood of similar losses repeating. This ongoing analysis of credit performance provides a feedback loop that serves to continually refine and enhance credit risk policies.
 
We assume risk through our origination of loans, investments in whole loans and mortgage securities, and our construction lending operations. As a result of standard representations and warranties to investors, we also retain credit exposure from repurchase obligations on certain types of mortgage sales.
 
The following shows a summary of reserves against our key credit risks as of December 31, 2007 (dollars in millions):
 
                             
              “Reserve”
       
Credit Risk Area
  Reserve Type   Balance     Balance     UPB  
 
Mortgage Banking:
                           
Loans held for sale(1)
  Market valuation reserve   $ 3,777     $ 3     $ 3,711  
Repurchase risk(2)
  Secondary market reserve     N/A       180       181,724  
                             
Thrift:
                           
Loans held for investment(3)
  Allowance for loan losses and estimated credit losses embedded in basis reductions due to loans transferred from HFS     16,454       872       16,728  
Non-investment grade and residual securities(4)
  Loss assumption in valuations     272       1,262       22,437  
Foreclosed assets
  Reduction in book value due to liquidation costs and/or property value deterioration     196       61       257  
                             
Total Credit Reserves
  $ 2,378          
                 
 
 
(1) Risks include possible borrower credit deterioration which could adversely impact loan salability; potential further deterioration of credit quality of loans previously repurchased for repurchase/warranty issues or through called deals; and actual losses exceeding losses that are assumed in our valuations. The reserve is for delinquent loans.
 
(2) Risks include repurchase of impaired loans due to early payment default or other repurchase and warranty violations beyond the amount reserved at time of sale.
 
(3) Risk includes credit losses exceeding the risk reserved for in the allowance. Total reserves include $398 million of allowance for loan losses and $474 million of credit losses estimated in the determination of the market value discount on transferred loans.
 
(4) Reserve balance for non-investment grade and residual securities represents the expected remaining cumulative losses.
 
Total credit-related reserves were $2.4 billion at December 31, 2007, compared to $619 million at December 31, 2006. For 2007, we recorded credit costs of $1.4 billion compared to $126.1 million for 2006.


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Non-Performing Assets
 
The following presents the details of our loan portfolio by product as of the dates indicated (dollars in thousands):
 
                                                                                 
    December 31  
    2007     2006     2005     2004     2003  
          % of
          % of
          % of
          % of
          % of
 
          Total
          Total
          Total
          Total
          Total
 
    Balance     Loans     Balance     Loans     Balance     Loans     Balance     Loans     Balance     Loans  
 
Total held for sale portfolio
  $ 3,776,904       18.7 %   $ 9,467,843       48.2 %   $ 6,024,184       42.1 %   $ 4,445,572       39.7 %   $ 2,573,248       25.7 %
                                                                                 
SFR mortgage loans and HELOCs
    12,555,889       62.1 %     6,507,221       33.1 %     5,427,270       38.0 %     4,450,921       39.7 %     5,587,409       55.7 %
Land and other mortgage loans
    660,550       3.3 %     375,215       1.9 %     260,615       1.8 %     158,468       1.4 %     162,329       1.6 %
Builder construction loans
    818,035       4.0 %     786,279       4.0 %     612,061       4.3 %     512,191       4.6 %     438,873       4.4 %
Consumer construction loans
    2,342,060       11.6 %     2,225,979       11.3 %     1,883,674       13.2 %     1,574,378       14.1 %     1,191,050       11.9 %
Revolving warehouse lines of credit
    48,633       0.2 %     246,778       1.3 %     48,616       0.3 %                        
                                                                                 
Total core held for investment loans
    16,425,167       81.2 %     10,141,472       51.6 %     8,232,236       57.6 %     6,695,958       59.8 %     7,379,661       73.6 %
Others(1)
    28,879       0.1 %     35,737       0.2 %     46,133       0.3 %     53,795       0.5 %     69,524       0.7 %
                                                                                 
Total held for investment portfolio
    16,454,046       81.3 %     10,177,209       51.8 %     8,278,369       57.9 %     6,749,753       60.3 %     7,449,185       74.3 %
                                                                                 
Total loans
  $ 20,230,950       100.0 %   $ 19,645,052       100.0 %   $ 14,302,553       100.0 %   $ 11,195,325       100.0 %   $ 10,022,433       100.0 %
                                                                                 
 
 
(1) This includes manufactured home loans and home improvement.
 
Loans are generally placed on non-accrual status when they are 90 days past due. Non-performing assets include non-performing loans and foreclosed assets. We record the balance of our assets acquired in foreclosure or by deed in lieu of foreclosure at estimated net realizable value.
 
The following summarizes our non-performing assets as of the dates indicated (dollars in thousands):
 
                                         
    December 31  
    2007     2006     2005     2004     2003  
 
Non-performing loans HFI
  $ 1,308,148     $ 108,483     $ 43,404     $ 49,122     $ 37,592  
Non-performing loans HFS
    5,737       54,347       20,805       54,611       38,855  
                                         
Total non-performing loans
    1,313,885       162,830       64,209       103,733       76,447  
REO
    196,049       21,638       8,817       19,161       23,677  
                                         
Total non-performing assets
  $ 1,509,934     $ 184,468     $ 73,026     $ 122,894     $ 100,124  
                                         
Past due 90 days or more as to interest or principal and accruing interest
  $ 4,081     $ 185     $     $     $  
                                         
Total non-performing assets to total assets
    4.61 %     0.63 %     0.34 %     0.73 %     0.76 %
                                         
 
At December 31, 2007, non-performing assets as a percentage of total assets was 4.61%, increasing from 0.63% at December 31, 2006. The weakening real estate market and the general tightening of underwriting in the mortgage industry continue to have a negative impact on our portfolios. It became increasingly difficult for distressed borrowers to find alternative financing in order to avoid foreclosure. This resulted in a higher percentage of loans going through foreclosure and a longer average time for us to liquidate our REO. We expect to have an even higher level of non-performing loans in the future due to the continued market disruption. In addition to our non-performing loans, we have loans classified as sub-standard in the amount of $1.7 billion at December 31, 2007 as


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disclosed in our Thrift Financial Report filed with the OTS. We consider the sub-standard loan classification when determining the allowance for loan losses.
 
Non-performing loans held for investment increased by $1.2 billion from December 31, 2006 to $1.3 billion at December 31, 2007, while non-performing loans held for sale decreased by $48.6 million during the same time period to $5.7 million. As a result of the increased delinquencies in these portfolios, foreclosure activities rose during the period, leading to REO of $196.0 million at December 31, 2007.
 
The following provides additional comparative data on non-performing loans for the loans HFI portfolio by division as of the dates indicated (dollars in thousands):
 
                                         
    December 31  
    2007     2006     2005     2004     2003  
 
SFR mortgage loans HFI
  $ 736,159     $ 66,360     $ 27,960     $ 20,957     $ 11,227  
Consumer construction
    77,562       25,957       9,446       9,553       9,025  
                                         
Total on-going businesses
    813,721       92,317       37,406       30,510       20,252  
                                         
Homebuilder
    480,157       8,981             11,546       9,704  
Other(1)
    14,270       7,185       5,998       7,066       7,636  
                                         
Total discontinued business activities
    494,427       16,166       5,998       18,612       17,340  
                                         
Total non-performing loans HFI
  $ 1,308,148     $ 108,483     $ 43,404     $ 49,122     $ 37,592  
                                         
Allowance for loan losses to non-performing loans HFI(2)
    30 %     58 %     127 %     108 %     140 %
                                         
 
 
(1) Includes loans from the home equity and discontinued products divisions.
 
(2) For December 31, 2007, including the embedded credit reserves of $474 million in transferred loans increase this ratio to 67%.
 
The increase in non-performing HFI loans is mainly seen in the SFR mortgage loans HFI division and the homebuilder division portfolios. As previously noted, the increases in non-performing loans in our SFR mortgage loans HFI division portfolio is primarily due to the delinquency worsening credit environment and declining home prices primarily as it relates to higher LTV products. The non-performing loans in our homebuilder division’s portfolio are in markets that have seen both price and sales declines over the last several months. For further discussion on this portfolio, see “Summary of Business Segment Results — Discontinued Business Activities — Homebuilder Division”.
 
Our non-accrual/non-performing loans by collateral type are summarized as follows (dollars in thousands):
 
                         
    December 31  
    2007     2006     2005  
 
Homebuilder loans
  $ 480,157     $ 8,981     $  
Consumer construction loans
    77,562       25,957       9,446  
SFR mortgage loans HFI and other non-accrual/non-performing loans
    756,166       127,892       54,763  
                         
Total non-accrual/non-performing loans
  $ 1,313,885     $ 162,830     $ 64,209  
                         
 
Of the total non-accrual loans at December 31, 2007, approximately $480.2 million of impaired homebuilder loans were accounted for in accordance with SFAS 114, “Accounting by Creditors for Impairment of a Loan” (“SFAS 114”). As of December 31, 2006 and 2005, there were no impaired loans accounted for in accordance with SFAS 114. For the year ended December 31, 2007, the average balance for the SFAS 114 impaired loans was $127.1 million. The allowance for loan losses related to those SFAS 114 impaired loans was $95.0 million at December 31, 2007. For the year ended December 31, 2007, no interest income was recognized on the SFAS 114


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impaired loans once they were deemed impaired. There were no significant non-accrual loans accounted for under SFAS 114 at December 31, 2006 and 2005.
 
Troubled debt restructurings, where management has granted a concession to a borrower experiencing financial difficulty, were approximately $33.1 million as of December 31, 2007. We have no significant commitments to lend additional funds to borrowers with restructured loans. There were no significant troubled debt restructuring loans at December 31, 2006 and 2005.
 
Allowance for Loan Losses
 
For the loans held for investment portfolio, an allowance for loan losses is established and allocated to various loan types for segment reporting purposes. The determination of the level of the allowance for loan losses and, correspondingly, the provision for loan losses, is based on delinquency trends, prior loan loss experience, and management’s judgment and assumptions regarding various matters, including general economic conditions and loan portfolio composition. Management continuously evaluates these assumptions and various relevant factors impacting credit quality and inherent losses. A component of the overall allowance for loan losses is not specifically allocated (“unallocated component”). The unallocated component reflects management’s assessment of various factors that create inherent imprecision in the methods used to determine the specific portfolio allocations. Those factors include, but are not limited to, levels of and trends in delinquencies and impaired loans, charge-offs and recoveries, volume and terms of the loans, effects of any changes in risk selection and underwriting standards, other changes in lending policies, procedures, and practices, and national and local economic trends and conditions. As of December 31, 2007, the unallocated component of the total allowance for loan losses was $72.5 million, compared to $17.2 million at December 31, 2006.
 
In the fourth quarter of 2007, we transferred mortgage loans with a net investment amount of $10.9 billion from HFS to HFI. We recorded a reduction to the net investment in the amount of $0.6 billion resulting in a net increase in HFI loans of $10.3 billion. A portion of the valuation reduction in net investment represents credit losses we estimated in determining the market value of loans. This amount, which totals $474 million, represents a “reserve” for future realized credit losses. If our estimate of inherent credit losses in the transferred pool increases, we may record a provision for loan losses which will increase the allowance for loan losses.
 
The following summarizes our loans HFI portfolio by division and the corresponding allowance for loan losses as of the dates indicated (dollars in thousands):
 
                                                                                 
    December 31  
    2007     2006     2005     2004     2003  
          ALL as a%
          ALL as a%
          ALL as a%
          ALL as a%
          ALL as a%
 
          of Recorded
          of Recorded
          of Recorded
          of Recorded
          of Recorded
 
By Division
  ALL     Value     ALL     Value     ALL     Value     ALL     Value     ALL     Value  
 
SFR mortgage loans HFI(1)
  $ 131,345       1.2 %   $ 21,540       0.3 %   $ 17,848       0.3 %   $ 15,575       0.4 %   $ 15,774       0.3 %
Consumer construction
    32,317       1.4 %     11,779       0.5 %     11,775       0.6 %     11,474       0.7 %     10,769       0.9 %
Warehouse lending
    344       0.7 %     298       0.1 %     117       0.2 %           N/A             N/A  
                                                                                 
Total on-going businesses
    164,006       1.2 %     33,617       0.4 %     29,740       0.4 %     27,049       0.5 %     26,543       0.4 %
Homebuilder
    198,590       16.7 %     20,448       1.8 %     16,648       1.9 %     15,748       2.4 %     14,838       2.5 %
Home equity
    30,452       2.1 %     2,452       10.4 %     2,443       7.7 %     2,394       5.2 %     4,263       0.6 %
Other
    5,087       17.6 %     5,869       16.4 %     6,337       13.7 %     7,700       14.3 %     7,001       10.1 %
                                                                                 
Total discontinued business activities
    234,129       8.7 %     28,769       2.4 %     25,428       2.7 %     25,842       3.4 %     26,102       1.9 %
                                                                                 
Total HFI portfolio
  $ 398,135       2.4 %   $ 62,386       0.6 %   $ 55,168       0.7 %   $ 52,891       0.8 %   $ 52,645       0.7 %
                                                                                 
 
 
(1) The recorded value as of December 31, 2007 includes basis adjustments of $581 million created upon the transfer of $10.9 billion of loans from HFS to HFI in the fourth quarter of 2007.
 
For the homebuilder division, the allowance for loan losses increased to $198.6 million, or 16.7% of the recorded value of its portfolio. We are monitoring this portfolio very closely due to rapidly changing conditions


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affecting both the underlying collateral values and the projected repayment sources in the current environment. The allowance for loan losses increased substantially on the SFR mortgage loans HFI division, homebuilder division, and home equity division portfolios as well as higher realized delinquency rates and other current environmental factors have resulted in our projecting higher future losses than were previously expected.
 
Summarized below are changes to the allowance for loan losses for the years indicated (dollars in thousands):
 
                                         
    Year Ended December 31  
    2007     2006     2005     2004     2003  
 
Balance, beginning of year
  $ 62,386     $ 55,168     $ 52,891     $ 52,645     $ 50,761  
Allowance transferred to loans HFS
    (7,574 )                        
Provision for loan losses
    395,548       19,993       9,978       8,170       19,700  
Charge-offs:
                                       
SFR mortgage loans HFI division
    (29,186 )     (6,003 )     (2,116 )     (1,810 )     (2,382 )
Consumer construction division
    (19,835 )     (3,549 )     (2,422 )     (1,492 )     (1,621 )
Homebuilder division
                            (3,136 )
Other(1)
    (7,138 )     (5,586 )     (4,979 )     (6,829 )     (12,242 )
                                         
Total charge-offs
    (56,159 )     (15,138 )     (9,517 )     (10,131 )     (19,381 )
                                         
Recoveries:
                                       
SFR mortgage loans HFI division
    1,200       470       639       336       233  
Consumer construction division
    117       231       127       29       102  
Other(1)
    2,617       1,662       1,050       1,842       1,230  
                                         
Total recoveries
    3,934       2,363       1,816       2,207       1,565  
                                         
Total charge-offs, net of recoveries
    (52,225 )     (12,775 )     (7,701 )     (7,924 )     (17,816 )
                                         
Balance, end of year
  $ 398,135     $ 62,386     $ 55,168     $ 52,891     $ 52,645  
                                         
Annualized charge-offs to average loans HFI
    0.52 %     0.14 %     0.10 %     0.11 %     0.34 %
 
 
(1) Includes loans from the warehouse lending, home equity and discontinued divisions.
 
In 2007, net charge-offs increased to $52.2 million from $12.8 million in 2006, primarily in the SFR mortgage loans HFI division and the consumer construction division portfolios. This is consistent with the overall conditions in both the mortgage and the housing markets that contributed to the overall increase in delinquencies and loans migrating through the foreclosure process.
 
While we consider the allowance for loan losses to be adequate based on information currently available, future adjustments to the allowance may be necessary due to changes in economic conditions, declines in real estate values, delinquency levels, foreclosure rates, or loss rates. The level of allowance for loan losses is also subject to review by the OTS. The OTS may require the allowance for loan losses be increased based on its evaluation of the information available to it at the time of its examination of the Bank.
 
With respect to mortgage loans HFS, pursuant to the applicable accounting rules, we do not provide an allowance for loan losses. Instead, a component for credit risk related to loans HFS is embedded in the market valuation for these loans. Given the changes in our production volume and quality, we expect this amount to be significantly less in 2008 than in 2007.
 
Credit Discounts
 
Due to the disruption in the secondary mortgage market, our HFS loans in 2007 decreased by $5.7 billion from 2006 primarily due to the $10.9 billion of cost basis in mortgage loans transferred from HFS to HFI in the fourth quarter of 2007.


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The following summarizes our HFS portfolio, the corresponding market valuation reserves and non-performing assets as of the dates indicated (dollars in thousands):
 
                                         
    December 31  
    2007     2006     2005     2004     2003  
 
Loans HFS before market valuation reserves
  $ 3,780,368     $ 9,507,307     $ 6,034,429     $ 4,456,604     $ 2,587,240  
Market valuation reserves
    (3,464 )     (39,464 )     (10,245 )     (11,032 )     (13,992 )
                                         
Net loans HFS portfolio
  $ 3,776,904     $ 9,467,843     $ 6,024,184     $ 4,445,572     $ 2,573,248  
                                         
Market valuation reserves as a % of gross loans HFS
    0.09 %     0.42 %     0.17 %     0.25 %     0.54 %
                                         
Non-performing loans HFS before market valuation reserves
  $ 8,227     $ 78,238     $ 31,050     $ 65,643     $ 52,847  
Market valuation reserves
    (2,490 )     (23,891 )     (10,245 )     (11,032 )     (13,992 )
                                         
Net non-performing loans HFS
    5,737     $ 54,347     $ 20,805     $ 54,611     $ 38,855  
                                         
Non-performing loans held for sale as a % of net loans HFS portfolio
    0.15 %     0.57 %     0.35 %     1.23 %     1.51 %
                                         
 
Secondary Market Reserve
 
We do not generally sell loans with recourse. However, we can be required to repurchase loans from investors when our loan sales contain individual loans that do not conform to the representations and warranties we made at the time of sale (including early payment default provisions). We maintain a secondary market reserve for losses that arise in connection with loans that we may be required to repurchase from whole loan sales, sales to the GSEs, and securitizations. The reserve has two general components: reserves for repurchases arising from representation and warranty claims and reserves for repurchases arising from early payment defaults.
 
The following reflects our loan sale and repurchase activities for the years indicated (dollars in millions):
 
                         
    Year Ended December 31  
    2007     2006     2005  
 
Loans sold:
                       
GSEs and whole loans
  $ 46,798     $ 47,878     $ 20,924  
Securitization trusts
    24,366       31,171       31,373  
                         
Total
  $ 71,164     $ 79,049     $ 52,297  
                         
Total repurchases(1)
  $ 613     $ 194     $ 108  
                         
Repurchases as a percentage of total loans sold during the year
    0.86 %     0.25 %     0.21 %
 
 
(1) Amounts exclude repurchases that are administrative in nature and generally are re-sold immediately at little or no loss.


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The following reflects our activity in the secondary market reserve for the years indicated (dollars in thousands):
 
                                         
    Year Ended December 31  
    2007     2006     2005     2004     2003  
 
Balance, beginning of year
  $ 33,932     $ 27,638     $ 35,610     $ 34,000     $ 37,636  
Additions/provisions
    232,536       37,333       19,551       22,922       26,706  
Actual losses/mark-to-market
    (88,022 )     (32,817 )     (28,860 )     (24,843 )     (34,805 )
Recoveries on previous claims
    1,346       1,778       1,337       3,531       4,463  
                                         
Balance, end of year
  $ 179,792     $ 33,932     $ 27,638     $ 35,610     $ 34,000  
                                         
 
Reserve levels are a function of expected losses based on actual pending and expected claims and repurchase requests, historical experience, loan volume and loan sales distribution channels and the assessment of the probability of investor claims. While the ultimate amount of repurchases and claims is uncertain, management believes the reserve is adequate. The provision for the secondary market reserve increased to $232.5 million for the year ended December 31, 2007 from $37.3 million for the year ended December 31, 2006. This increase is due to the rise in representation and warranty demands and expected demands due to the deteriorating loan performance, particularly in 80/20 products where we have observed increasing delinquency and repurchase demands. We had charges to the secondary market reserve of $88.0 million in 2007, mainly for mark-to-market adjustments on loans repurchased during the year, of which 80/20s and pay option ARMs accounted for over 80% of the adjustments. As previously noted, we no longer originate 80/20s and pay option ARMs. We will continue to evaluate the adequacy of our reserve and allocate a portion of our gain on sale proceeds to the reserve going forward although we cannot predict at this time the extent to which we will allocate such gain on sale to the reserve. This secondary market reserve is included on the consolidated balance sheets as a component of “Other Liabilities”.
 
Credit Reserves Embedded in Non-Investment Grade and Residual Securities
 
As part of the securitization process, we create non-investment grade and residual securities which historically could be sold into the secondary market or retained on our balance sheet. These securities provide credit enhancement to absorb the losses in the securitization trust. Worsening loan performance has necessitated an increase in the amount of credit losses estimated in these securities.
 
The following shows more information on our non-investment grade and residual securities for the years indicated (dollars in millions):
 
                         
    Year Ended December 31  
    2007     2006     2005  
 
Non-investment Grade and Residual Securities:
                       
Fair market value
  $ 272     $ 331     $ 225  
As a percentage of Tier 1 (core) capital
    14 %     16 %     14 %
UPB of underlying collateral
    22,437       13,361       7,961  
Credit reserves embedded in value
    1,262       477       266  
Additions to credit reserves
    1,020       238       136  
Net realized credit losses
    235       27       15  
Credit reserves/non-performing assets
    78 %     77 %     140 %
 
MANAGEMENT
 
We manage key CAMELS risks through policies and procedures that begin with the Board, senior executives and the ERM group, creating standardized frameworks and processes for the business units to implement. We strive for accountability, transparency and consistency, including a semi-annual certification process that keeps business units up to date on the administration of key CAMELS risks. Management maintains a central database of internally


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identified findings, and this, in conjunction with operational and financial controls, requires follow-up and accountability for any issues identified in this process.
 
Models are used as key decision making tools in executing transactions, such as the pricing and trading of loans, and in hedging risks. They are also used to assist us in valuing assets and liabilities that don’t have readily available market prices. Given the importance of these models to our operations and financial position, it is the responsibility of Corporate Model Management and Research (“CMMR”) to develop and maintain an effective model management framework across the Company. CMMR determines that key models are consistent and accurate (e.g., utilize the best available assumptions, particularly for prepayment and credit) across the enterprise and result in the correct economic decisions being made and assets and liabilities being properly valued (both on a GAAP and economic basis).
 
EARNINGS
 
Our regulators evaluate the quality and consistency of our earnings. See “Narrative Summary of Consolidated Financial Results” and “Summary of Business Segment Results” for a discussion of our earnings for the years ended December 31, 2007 and 2006.
 
LIQUIDITY
 
During 2007, the secondary market for MBS and asset-backed securities (“ABS”) experienced significant disruption resulting in a further decline in overall market liquidity. In response to these disruptions, we further increased our emphasis of its funding strategy to deposits and borrowings from the Federal Home Loan Bank (“FHLB”). As a result of this effort, we were able to increase our deposits and advances from FHLB by $6.9 billion and $0.8 billion, respectively, during the year.
 
Our principal financing needs are to fund acquisitions of mortgage loans and our investment in mortgage loans, MBS and MSRs. Our primary sources of funds used to meet these financing needs are loan sales and securitizations, deposits, advances from the FHLB, borrowings, custodial balances and retained earnings. The sources used vary depending on such factors as rates paid, collateral requirements, maturities and the impact on our capital. Additionally, we may occasionally securitize mortgage loans that we intend to hold for investment to lower our costs of borrowing against such assets and reduce the capital requirement associated with such assets.
 
At December 31, 2007, we had total liquidity of $6.3 billion consisting of $0.5 billion in short-term liquidity (primarily cash), and $4.8 billion in operating liquidity, which represents unpledged liquid assets on hand plus amounts that may be immediately raised through the pledging of other available assets as collateral pursuant to committed financing facilities, and we also had access to $1.0 billion in financing at the Federal Reserve Discount Window. We currently believe our liquidity level is sufficient to satisfy our operating requirements and meet our obligations and commitments in a timely and cost effective manner.


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The following presents the components of our major sources of funds as of the dates indicated (dollars in thousands):
 
                         
    December 31        
    2007     2006        
 
Deposits
  $ 17,815,243     $ 10,898,006          
Advances from FHLB
    11,188,800       10,412,800          
Other Borrowings:
                       
Asset-backed commercial paper
          2,115,839          
Loans and securities sold under agreements to repurchase
          1,407,199          
HELOC notes payable
    212,747       659,283          
Trust preferred debentures
    441,285       456,695          
Other notes payable
          1,009          
Others(1)
    (1,254 )     (3,025 )        
                         
Total other borrowings
    652,778       4,637,000          
                         
    $ 29,656,821     $ 25,947,806          
                         
 
 
(1) This represents unamortized portion of the facility issue cost and commitment fee.
 
Principal Sources of Cash
 
Loan Sales and Securitizations
 
Our business model has relied heavily upon selling the majority of our mortgage loans shortly after acquisition. The proceeds of these sales are a critical component of our liquidity. Due to the disruption of the MBS and ABS secondary markets, loan sales and securitizations were adversely impacted, resulting in lower than normal volume. Thus, we significantly changed our production model and transitioned to become a GSE lender. During the year ended December 31, 2007, we sold $71.2 billion of mortgage loans, which represented approximately 92% of our funded mortgage loans during the year, to third-party investors through three channels: (1) GSEs; (2) private label securitizations; and (3) whole loan sales. Our prime SFR mortgage loans HFI portfolio also acquired $10.9 billion of loans for our portfolio of HFI mortgage loans from our HFS portfolio due primarily to our inability to sell these loans in the secondary market. These loans will also provide future interest income. The remainder of our funded mortgage loans during the year is retained in our HFS portfolio for future sale.
 
Our business model has been negatively impacted as our sales channels continue to be disrupted. As a result, our earnings were also adversely impacted. If these disruptions continue, or there are other economic events or factors beyond our control, our earnings could continue to be negatively impacted.
 
Deposits/Retail Bank
 
We solicit deposits from the general public and institutions by offering a variety of accounts and rates through our network of 33 branches (up from 29 branches as of December 31, 2006) in Southern California and our telebanking, Internet, and Money Desk and Institutional channels. Through our web site at www.imb.com, consumers can access their accounts 24-hours a day, seven days a week. Online banking allows customers to access their accounts, view balances, transfer funds between accounts, view transactions, download account information, and pay their bills conveniently from any computer terminal. Total deposits increased to $17.8 billion at December 31, 2007, up from $10.9 billion at December 31, 2006. We estimate that in excess of 95% of our total deposits are fully insured by the FDIC.
 
Advances from the Federal Home Loan Bank
 
The FHLB system functions as a borrowing source for regulated financial depositories and similar institutions engaged in residential housing finance. As a member of the FHLB of San Francisco, we are required to own capital stock of the FHLB and are authorized to apply for advances from the FHLB, on a secured basis, in amounts


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determined by reference to available collateral. SFR mortgage loans, agency and AAA-rated MBS are the principal collateral that may be used to secure these borrowings, although certain other types of loans and other assets may also be accepted pursuant to FHLB policies and statutory requirements. The FHLB offers several credit programs, each with its own fixed or floating interest rate, and a range of maturities.
 
Currently, Indymac Bank is approved for collateralized advances from FHLB of up to $16.7 billion. At December 31, 2007, advances from the FHLB totaled $11.2 billion, of which $7.2 billion were collateralized by mortgage loans and $4.0 billion were collateralized by MBS.
 
Other Borrowings
 
Other borrowings, excluding the subordinated debentures underlying the trust preferred securities, consist of asset-backed commercial paper (“ABCP”), loans and securities sold under committed financing facilities and uncommitted agreements to repurchase, and notes payable. Total other borrowings decreased to $0.2 billion at December 31, 2007, from $4.2 billion at December 31, 2006. Our repurchase agreement borrowings and extendible asset-backed commercial paper remained unused as of December 31, 2007 as a result of our strategy to increase our deposits and advances from the FHLB.
 
Our credit facilities do not have default triggers tied to our credit rating. While a change in rating would therefore not directly affect our current borrowing capacity in a material manner, it might affect our lenders’ decisions to renew credit facilities with us or it may change market perceptions and impact our trading and loan sales activities.
 
Below are the corporate ratings assigned to IndyMac Bancorp and Indymac Bank at December 31, 2007 and January 24, 2008:
 
                                         
                      Dominion Bond
    Fitch, IBCA,
    Moody’s     Standard & Poor’s   Rating Service     Duff & Phelps
    2007   2008(1)     2007   2008   2007   2008(1)     2007   2008
 
IndyMac Bancorp:
                                       
Outlook
  Review for
downgrade
     —     Negative   Negative   Negative         Negative   Negative
Long term issuer credit
  Ba2         BB+   BB+   BBH         BBB−   BB
Short term issuer credit
  N/A         B   B   R4         F3   B
Indymac Bank:
                                       
Outlook
  Review for
downgrade
        Negative   Negative   Negative         Negative   Negative
Long term issuer credit
  Ba1         BBB−   BBB−   BBBL         BBB−   BB
Short term issuer credit
  NP         A3   A3   R3         F3   B
 
 
(1) We terminated the rating relationship with Moody’s and Dominion, and they subsequently withdrew their ratings at our request in January 2008.
 
The Enterprise Risk Management Committee, in its capacity as a committee of the Indymac Board of Directors, is directly responsible for the oversight of the Company’s relationships with external credit rating agencies. For fiscal year ended December 31, 2007, Indymac paid approximately $17.7 million in aggregate fees to external credit rating agencies, of which $15.1 million was for services related to securitizations, with the balance for services related to servicer ratings and other corporate rating related transactions.


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Direct Stock Purchase Plan
 
Our direct stock purchase plan offers investors the ability to purchase shares of our common stock directly over the Internet. During the year ended December 31, 2007, we raised $145.6 million of capital by issuing 7,427,104 shares of common stock through this plan.
 
SENSITIVITY TO MARKET RISK
 
A key area of risk for us is interest rate risk sensitivity. This is due to the impact that changes in interest rates can have on the demand for mortgages, as well as the value of loans in our pipeline and assets on our balance sheet, particularly the valuation of our MSRs. To manage interest rate risk sensitivity we have a Centralized Interest Rate Risk Group (“CIRRG”). CIRRG fosters an interest rate and market risk management culture throughout the Company and exists to assist in protecting the Company from unexpected losses, earnings surprises and reputation damage due to interest rate risk. It also provides management and the Board with a better understanding of the trade-offs between risk and rewards, leading to smarter risk management and investment decisions, and more consistent and generally higher long term returns on equity. We hedge our assets at the portfolio level to ensure accountability and make certain that each portfolio can stand on its own.
 
To evaluate our ability to manage interest rate risk, there are a number of performance measures we track. These include net interest margin for both the total Company as well as our segments, the fluctuation in net interest income and expense and average balances, and the net portfolio value of our net assets.


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Net Interest Margin
 
The following presents information regarding our consolidated average balance sheets (all segments are combined), along with the total dollar amounts of interest income and interest expense and the weighted-average interest rates for the years indicated (dollars in thousands):
 
                                                                         
    Year Ended December 31  
    2007     2006     2005  
    Average
          Yield/
    Average
          Yield/
    Average
          Yield/
 
    Balance     Interest     Rate     Balance     Interest     Rate     Balance     Interest     Rate  
 
Assets
                                                                       
Securities
  $ 5,753,699     $ 406,376       7.06 %   $ 4,658,402     $ 319,846       6.87 %   $ 3,652,102     $ 208,560       5.71 %
Loans held for sale
    14,063,412       994,886       7.07 %     11,488,630       797,460       6.94 %     7,746,762       430,857       5.56 %
Mortgage loans held for investment
    7,039,623       460,898       6.55 %     6,243,353       365,158       5.85 %     5,282,342       256,427       4.85 %
Builder construction loans
    812,129       72,179       8.89 %     735,841       76,006       10.33 %     578,865       51,772       8.94 %
Consumer construction loans
    2,237,473       179,706       8.03 %     2,014,213       144,574       7.18 %     1,627,281       97,656       6.00 %
Investment in FHLB stock and other
    1,325,850       73,662       5.56 %     887,837       47,972       5.40 %     757,659       29,083       3.84 %
                                                                         
Total interest-earning assets
    31,232,186       2,187,707       7.00 %     26,028,276       1,751,016       6.73 %     19,645,011       1,074,355       5.47 %
                                                                         
Mortgage servicing assets
    2,201,169                       1,436,725                       786,622                  
Other
    2,535,667                       1,843,873                       846,260                  
                                                                         
Total assets
  $ 35,969,022                     $ 29,308,874                     $ 21,277,893                  
                                                                         
Liabilities and Shareholders’ Equity
                                                                       
Interest-bearing deposits
  $ 12,790,494       663,217       5.19 %   $ 8,663,777       408,208       4.71 %   $ 5,938,147       195,528       3.29 %
Advances from Federal Home Loan Bank
    13,531,225       701,226       5.18 %     10,560,896       491,300       4.65 %     8,439,903       281,929       3.34 %
Other borrowings
    4,393,049       256,522       5.84 %     5,985,486       324,787       5.43 %     4,235,298       172,187       4.07 %
                                                                         
Total interest-bearing liabilities
    30,714,768       1,620,965       5.28 %     25,210,159       1,224,295       4.86 %     18,613,348       649,644       3.49 %
                                                                         
Other
    3,277,322                       2,302,455                       1,283,678                  
                                                                         
Total liabilities
    33,992,090                       27,512,614                       19,897,026                  
Shareholders’ equity
    1,976,932                       1,796,260                       1,380,867                  
                                                                         
Total liabilities and shareholders’ equity
  $ 35,969,022                     $ 29,308,874                     $ 21,277,893                  
                                                                         
Net interest income
          $ 566,742                     $ 526,721                     $ 424,711          
                                                                         
Net interest spread(1)
                    1.72 %                     1.87 %                     1.98 %
                                                                         
Net interest margin(2)
                    1.81 %                     2.02 %                     2.16 %
                                                                         
 
 
(1) Net interest spread calculated as the yield on total average interest-earnings assets less the yield on total average interest-bearing liabilities.
 
(2) Net interest margin calculated as annualized net interest income divided by total average interest-earning assets.
 
Average balances are calculated on a daily basis. Non-performing loans are included in the average balances for the years presented. The allowance for loan losses is excluded from the average loan balances and included in the average other assets line. Minority interests and perpetual preferred stock in subsidiary are included in average other liabilities.


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Interest income and interest expense fluctuations depend upon changes in the average balances and interest rates of interest-earning assets and interest-bearing liabilities.
 
The following details the changes in interest income and expense by key attribute for the years indicated (dollars in thousands):
 
                                 
    Increase/(Decrease) Due to  
    Volume(1)     Rate( 2)     Mix(3)     Total Change  
 
Year Ended December 31, 2007 vs. 2006
                               
Interest income:
                               
Mortgage-backed securities
  $ 75,203     $ 9,171     $ 2,156     $ 86,530  
Loans held for sale
    178,723       15,279       3,424       197,426  
Mortgage loans held for investment
    46,572       43,607       5,561       95,740  
Builder construction loans
    7,880       (10,607 )     (1,100 )     (3,827 )
Consumer construction loans
    16,025       17,201       1,906       35,132  
Investment in Federal Home Loan Bank stock and other
    23,667       1,355       668       25,690  
                                 
Total interest income
    348,070       76,006       12,615       436,691  
Interest expense:
                               
Interest-bearing deposits
    194,437       41,029       19,543       255,009  
Advances from Federal Home Loan Bank
    138,182       55,995       15,749       209,926  
Other borrowings
    (86,409 )     24,722       (6,578 )     (68,265 )
                                 
Total interest expense
    246,210       121,746       28,714       396,670  
                                 
Net interest income (expense)
  $ 101,860     $ (45,740 )   $ (16,099 )   $ 40,021  
                                 
Year Ended December 31, 2006 vs. 2005
                               
Interest income:
                               
Mortgage-backed securities
  $ 57,467     $ 42,193     $ 11,626     $ 111,286  
Loans held for sale
    208,114       106,869       51,620       366,603  
Mortgage loans held for investment
    46,651       52,524       9,556       108,731  
Builder construction loans
    14,039       8,020       2,175       24,234  
Consumer construction loans
    23,220       19,145       4,553       46,918  
Investment in Federal Home Loan Bank stock and other
    4,997       11,855       2,037       18,889  
                                 
Total interest income
    354,488       240,606       81,567       676,661  
Interest expense:
                               
Interest-bearing deposits
    89,748       84,257       38,675       212,680  
Advances from Federal Home Loan Bank
    70,850       110,701       27,820       209,371  
Other borrowings
    71,154       57,631       23,815       152,600  
                                 
Total interest expense
    231,752       252,589       90,310       574,651  
                                 
Net interest income (expense)
  $ 122,736     $ (11,983 )   $ (8,743 )   $ 102,010  
                                 
 
 
(1) Changes in volume are calculated by taking changes in average balances multiplied by the prior year’s average interest rate.
 
(2) Changes in the rate are calculated by taking changes in the average interest rate multiplied by the prior year’s average balance.
 
(3) Changes in rate/volume (“mix”) are calculated by taking changes in rates times the changes in volume.


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Net Interest Margin by Segment
 
The following summarize net interest margin by segment for the years indicated (dollars in millions):
 
                                                                         
    Year Ended December 31  
    2007     2006     2005  
    Average
    Net
    Net
    Average
    Net
    Net
    Average
    Net
    Net
 
    Earning
    Interest
    Interest
    Earning
    Interest
    Interest
    Earning
    Interest
    Interest
 
    Assets     Income     Margin     Assets     Income     Margin     Assets     Income     Margin  
 
By Segment:
                                                                       
Thrift segment and other
  $ 15,442     $ 334       2.16 %   $ 12,536     $ 265       2.11 %   $ 10,228     $ 232       2.27 %
Mortgage banking segment
    8,386       93       1.11 %     6,292       81       1.28 %     4,689       63       1.34 %
                                                                         
Total on-going businesses
    23,828       427       1.79 %     18,828       346       1.83 %     14,917       295       1.98 %
Discontinued business activities
    7,404       140       1.89 %     7,200       181       2.52 %     4,728       130       2.75 %
                                                                         
Total Company
  $ 31,232     $ 567       1.81 %   $ 26,028     $ 527       2.02 %   $ 19,645     $ 425       2.16 %
                                                                         
 
The consolidated net interest margin during 2007 was 1.81%, down from 2.02% for 2006. Thrift net interest margin of 2.16% for 2007 increased slightly from 2.11% for 2006.
 
Loans Held for Sale and Pipeline Hedging
 
We hedge the interest rate risk inherent in our pipeline of mortgage loans held for sale to protect our margin on sale of loans. We focus on trying to maintain stable profit margins with an emphasis on forecasting expected fallout to more precisely estimate our required hedge coverage ratio and minimize hedge costs. By closely monitoring key factors, such as product type, origination channels, progress or “status” of transactions, as well as changes in market interest rates since we committed a rate to the borrower (“rate lock commitments”), we seek to quantify the optional component of each rate lock, and in turn, the aggregate rate lock pipeline. By accurately evaluating these factors, we can minimize the cost of hedging and also stabilize gain on sale margins over different rate environments.
 
We also attempt to hedge the type of spread widening caused by the secondary market disruptions started in the first quarter of 2007. However, given the current uncertainties and resulting volatility in the secondary market, our hedging activities may not be effective. When spread widening does occur, we increase our loan pricing to attain our target MBR margins on future production.
 
In addition to mortgage loans held for sale, our hedging activities also include rate lock commitments. Rate lock commitments on mortgage loans that are intended to be sold are considered to be derivatives pursuant to SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” (“SFAS 133”). The rate lock commitments are initially valued at zero and continue to be adjusted for changes in value resulting from changes in market interest rates, pursuant to SAB 105. Staff Accounting Bulletin No. 109, “Written Loan Commitments Recorded at Fair Value Through Earnings” (“SAB 109”) supersedes SAB 105 and is effective prospectively for loan commitments issued or modified beginning January 1, 2008. Upon adoption of SAB 109, we will recognize revenue at the inception of a rate lock commitment.
 
We economically hedge the risk of changes in fair value of rate lock commitments by selling forward contracts on securities of Fannie Mae or Freddie Mac, Eurodollar futures and other hedge instruments as we deem appropriate to prudently manage this risk. These forward and futures contracts are also accounted for as derivatives and recorded at fair value.


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The following summarizes the effect that hedging for interest rate risk management had on our gross mortgage banking revenue margin for the years indicated:
 
                                         
    Year Ended December 31  
    2007     2006     % Change     2005     % Change  
 
Gross MBR margin
    1.00 %     1.50 %     (33 )%     1.59 %     (37 )%
MBR margin after hedging(1)
    0.99 %     1.41 %     (30 )%     1.70 %     (42 )%
 
 
(1) Before credit costs and SFAS 91 deferred costs.
 
Hedging Interest Rate Risk On Servicing-Related Assets
 
We are exposed to interest rate risk with respect to the investment in servicing-related assets. The mortgage servicing division is responsible for the management of interest rate and prepayment risks in the servicing-related assets, subject to policies and procedures established by, and oversight from, our management-level Interest Rate Risk Committee (“IRRC”), Asset and Liability Valuation Committee (“ALVC”) and ERM group, and our Board of Directors-level ERM Committee.
 
The objective of our hedging strategy is to maintain stable returns in all interest rate environments and not to speculate on interest rates. As such, we manage the comprehensive interest rate risk of our servicing-related assets using various financial instruments. Historically, we have hedged servicing-related assets using a variety of derivative instruments and on-balance sheet securities. As there are no hedge instruments that would be perfectly correlated with these hedged assets, we use a mix of the instruments designed to correlate well with the hedged servicing assets.
 
In addition to the hedging gain (loss) on MSRs, we also use other hedging strategies to manage our economic risks associated with MSRs.
 
A summary of the performance on MSRs, including AAA-rated and agency interest-only securities, and hedges for the respective years follows (dollars in thousands):
 
                         
    Year Ended December 31  
    2007     2006     2005  
 
Valuation adjustment due to market changes and external benchmarking
  $ 156,327     $ 7,721     $ (13,460 )
Hedge loss on MSRs
    61,476       (32,353 )     2,360  
Hedge (loss) gain on AAA-rated and agency interest-only securities
    2,346       (8,678 )     2,348  
Unrealized gain on AAA-rated and agency interest-only securities
    (734 )     3,136       (13,864 )
Unrealized (loss) gain on principal-only securities
    (1,852 )     (811 )     (704 )
Unrealized (loss) gain on prepayment penalty securities
    (44,215 )     23,625       21,694  
                         
Net (loss) gain on MSRs, AAA-rated and agency interest-only securities, and hedges
  $ 173,348     $ (7,360 )   $ (1,626 )
                         
 
The above gains and losses include costs inherent in transacting and holding the hedge instruments. If these assets were perfectly hedged, a net loss would have been reported representing these costs. In 2007, hedges on the servicing-related assets had a net gain of $61.5 million as they benefited from the decline in market interest rates. Moreover, our MSRs experienced a decline in value less than expected from the decline in interest rates as a result of slower prepayment rates currently and in the future.
 
Value-at-Risk
 
We use a value-at-risk (“VAR”) measure to monitor the interest rate risk on our assets. The measure incorporates a range of market factors that can impact the value of these assets and supplements other risk measures such as duration gap and stress testing. VAR estimates the potential loss over a specified period at a


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specified confidence level. We have chosen a historical approach that uses 500 days of market conditions along with current portfolio data to estimate the potential one-day loss at a 95% confidence level. This means that actual losses are estimated to exceed the VAR measure about five times every 100 days.
 
In modeling the VAR, we have made a number of assumptions and approximations. As there is no standardized methodology for estimating VAR, different assumptions and approximations could result in materially different VAR estimates.
 
As of December 31, 2007, the combined portfolio of MSRs and interest-only securities (the “MSR/IO portfolio”) and the mortgage-backed securities portfolio were valued at $2.4 billion and $6.4 billion, respectively. The average VAR (after the effect of hedging transactions) for the year on the MSR/IO portfolio was $3.4 million, or 14 basis points of the recorded value, and the average VAR (after the effect of hedging transactions) for the year on the MBS portfolio was $1.3 million, or 2 basis points of the recorded value. During the year, the VAR measure ranged from $1.3 million to $7.8 million and from $0.8 million to $2.6 million for the MSR/IO and MBS portfolios, respectively.
 
Net Portfolio Value
 
In addition to our hedging activities to mitigate the interest rate risk in our pipeline of mortgage loans held for sale, rate locks and our investment in servicing-related assets, we perform extensive, company-wide interest rate risk management. A primary measurement tool used to evaluate interest rate risk over the comprehensive balance sheet is net portfolio value (“NPV”) analysis. The NPV analysis and duration gap estimate the exposure of the fair value of net assets attributable to changes in interest rates.
 
The following sets forth the NPV and change in NPV that we estimate might result from a 100 basis point change in interest rates as of the dates indicated (dollars in thousands):
 
                                                 
    December 31, 2007     December 31, 2006  
          Effect of Change in
          Effect of Change in
 
          Interest Rates           Interest Rates  
          Decrease
    Increase
          Decrease
    Increase
 
    Fair Value     100 bps     100 bps     Fair Value     100 bps     100 bps  
 
Cash and cash equivalents
  $ 561,567     $ 561,567     $ 561,567     $ 541,545     $ 541,545     $ 541,545  
Trading securities
    1,221,319       1,277,821       1,181,673       541,175       573,028       522,503  
Available for sale securities
    5,892,727       6,011,674       5,725,050       4,183,629       4,272,980       4,064,097  
Loans held for sale
    3,814,287       3,977,569       3,804,344       9,566,224       9,645,767       9,440,968  
Loans held for investment
    15,655,523       15,944,607       15,351,165       10,191,350       10,266,772       10,081,430  
MSRs
    2,495,407       1,953,198       2,898,889       1,822,455       1,393,979       2,142,276  
Other assets
    1,807,917       2,084,403       1,610,292       1,992,698       2,317,284       1,813,516  
                                                 
Total assets
  $ 31,448,747     $ 31,810,839     $ 31,132,980     $ 28,839,076     $ 29,011,355     $ 28,606,335  
                                                 
Deposits
  $ 17,886,754     $ 17,933,343     $ 17,840,519     $ 11,045,977     $ 11,076,458     $ 11,015,812  
Advances from Federal Home Loan Bank
    11,355,215       11,559,467       11,153,554       10,409,767       10,565,054       10,256,128  
Other borrowings
    (1,150 )     (1,150 )     (1,150 )     3,464,290       3,466,577       3,462,006  
Other liabilities
    477,180       477,180       477,180       775,455       775,455       775,455  
                                                 
Total liabilities
  $ 29,717,999     $ 29,968,840     $ 29,470,103     $ 25,695,489     $ 25,883,544     $ 25,509,401  
                                                 
Shareholders’ equity (NPV)
  $ 1,730,748     $ 1,841,999     $ 1,662,877     $ 3,143,587     $ 3,127,811     $ 3,096,934  
                                                 
% Change from base case
            6.43 %     (3.92 )%             (0.50 )%     (1.48 )%
                                                 
 
Our NPV model has been built to focus on the Bank alone and excludes $226.7 million of assets held at Indymac Bancorp and its non-bank subsidiaries.


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The decrease in the NPV of shareholders’ equity from December 31, 2006 to December 31, 2007 is primarily due to net operating losses and declines in asset values relative to liabilities during the year. This NPV analysis is based on an instantaneous change in interest rates and does not reflect the impact of changes in hedging activities as interest rates change nor changes in volumes and profits from our mortgage banking operations that would be expected to result from the interest rate environment.
 
In conjunction with the NPV analysis, we also estimate the net sensitivity of the fair value of our financial instruments to movements in interest rates using duration gap. This calculation is performed by estimating the change in dollar value due to an instantaneous parallel change in the interest rate curve. The resulting change in dollar value per one basis point change in interest rates is used to estimate the sensitivity of our portfolio. The dollar values per one basis point change are then aggregated to estimate the portfolio’s net sensitivity. To calculate duration gap, the net sensitivity is divided by the fair value of total interest-earning assets and expressed in months. A duration gap of zero implies that the change in value of assets from an instantaneous rate move will be accompanied by an equal and offsetting move in the value of debt and derivatives, thus leaving the net fair value of equity unchanged.
 
The assumptions inherent in our interest rate shock models include expected valuation changes in an instantaneous and parallel interest rate shock and assumptions as to the degree of correlation between the hedges and hedged assets and liabilities. These assumptions may not adequately reflect factors such as the spread-widening or spread-tightening risk among the changes in rates on Treasury securities, the LIBOR/swap curve, mortgages, changes in the shape of the yield curve and volatility. In addition, the sensitivity analysis described in the prior paragraph is limited by the fact that it is performed at a particular point in time and does not incorporate other factors that would impact our financial performance in these scenarios, such as increases in income associated with the increase in production volume that could result from a decrease in interest rates. Consequently, the preceding estimates should not be viewed as a forecast, and it is reasonable to expect that actual results could vary significantly from the analyses discussed above.
 
At December 31, 2007, net duration gap for our mortgage banking and thrift segments was negative 16.9 months and 0.8 months, respectively, with the overall net duration gap of negative 3.0 months. Fair value gains and losses will generally occur as market conditions change. We actively manage duration risk through asset selection by appropriate funding and hedging to within the risk limits approved by senior management and the Board of Directors. The duration gap measures are estimated on a daily basis for the mortgage servicing rights, mortgage backed securities, whole loan investment, and pipeline portfolios and on a monthly basis for the other assets in our thrift portfolio.
 
EXPENSES
 
Our operating expenses for the year ended December 31, 2007 were $973.7 million, up 23% from $789.0 million for the year ended December 31, 2006.
 
The increase in expenses is primarily due to the increase in our salaries and related expenses by $80.7 million. This is due to the 20% growth of our average FTEs from 7,935 for the year ended December 31, 2006 to 9,518 for the year ended December 31, 2007, which was primarily the result of the expansion of our retail lending group and some necessary growth in loan servicing and default management functions. We continued our investments in the retail channel and commercial mortgage banking division, with the bulk of the increase coming from the April 1, 2007 acquisition of the retail lending platform of NYMC, including roughly 400 employees, and the hiring of over 1,400 retail lending professionals in the third quarter of 2007 primarily from American Home Mortgage. In addition, we recorded $28 million severance-related charges in the third quarter of 2007 as a result of the reduction of our workforce through both the voluntary resignation with severance program and targeted involuntary layoffs for regular employees and reductions in our offshore and temporary workforce. These increases were offset partially by the reduction of roughly 1,500 positions, or 15% of our non-retail lending workforce in 2007.
 
Another factor contributing to the increase in expenses were REO related expenses which significantly increased by $42.2 million in 2007 as compared to 2006. The significant increase was driven by the further write-downs on REOs resulting from the rapid decline in values. Also, our REO related expenses increased due to higher foreclosures resulting from worsened delinquencies in our portfolio.


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Refer to “Note 16 — Non-Interest Expense” in the accompanying notes to consolidated financial statements for a summary of expenses.
 
PROSPECTIVE TRENDS AND FUTURE OUTLOOK
 
We have a solid and a realistic plan that we believe will return Indymac to profitability in 2008. While forecasting continues to be a challenge as the housing and mortgage market remain uncertain and volatile, we believe that our new, more GSE-oriented mortgage production business will be profitable beginning in the second quarter of 2008. While we are projecting a loss in the first quarter of 2008, which is driven by restructuring charges from the workforce reduction we announced in January, we currently project a return to profitability in the second quarter of 2008 and growth in profits in the subsequent quarters of the year.
 
We expect our return to profitability to be driven by reduced credit costs and operating expenses, conversion of our production model and the continued strong performance of our mortgage servicing business. We believe we will see significant improvement in credit costs in 2008, given the large reserves we established in 2007 and because the new loans we are now originating are predominantly those eligible for sale to the GSEs, whereas the vast majority of the loans causing the losses in 2007 are in loan types that have been cut from our guidelines. In addition, we are rapidly making the transition from primarily an Alt-A lender to being a GSE lender, and we are seeing our mortgage production volumes stabilize. Also, we expect the reduction in our workforce announced in January 2008 and other efficiency measures to provide us with substantial annual savings and be essential in our drive to returning Indymac to profitability.
 
This “Prospective Trends and Future Outlook” section contains certain forward-looking statements. See “Part I — Forward-Looking Statements” for a description of factors which may cause our actual results to differ from those anticipated.
 
OFF-BALANCE SHEET ARRANGEMENTS
 
In the ordinary course of our business, we engage in financial transactions that are not recorded on our balance sheet. These transactions are structured to manage our interest rate, credit or liquidity risks, to diversify funding sources or to optimize our capital usage.
 
Substantially all of our off-balance sheet arrangements related to the securitization of mortgage loans. Our mortgage loan securitizations are normally structured as sales in accordance with SFAS 140, which involves the transfer of the mortgage loans to “qualifying special-purpose entities” that are not subject to consolidation. In a securitization, an entity transferring the assets is able to convert those assets into cash. Special-purpose entities used in such securitizations obtain cash to acquire the assets by issuing securities to investors. We also, generally, have the right to repurchase mortgage loans from the special-purpose entities if the remaining outstanding balance of the mortgage loans falls to a level where the cost of servicing the loans exceeds the revenues we earn.
 
In connection with our loan sales that are securitization transactions, there are $74.8 billion in loans owned by off-balance sheet trusts as of December 31, 2007. The trusts have issued bonds secured by these loans. We have no obligation to provide funding support to either the third-party investors or the off-balance sheet trusts. Generally, neither the third-party investors nor the trusts have recourse to our assets or us, and they have no ability to require us to repurchase their loans other than for non-credit-related recourse that can arise under standard representations and warranties. We maintain secondary market reserves mostly for losses that could arise in connection with loans that we are required to repurchase from GSEs, whole loan sales and securitizations. For information on the sales proceeds and cash flows from our securitizations for 2007, see “Consolidated Risk Management Discussion — CAMELS Framework for Risk Management — Liquidity — Principal Sources of Cash — Loan Sales and Securitizations.”
 
We usually retain certain interests, which may include subordinated classes of securities, MSRs, AAA-rated and agency interest-only securities, prepayment penalty and residual securities in the securitization trust. The performance of the loans in the trusts will impact our ability to realize the current estimated fair value of these assets that are included on our balance sheet. For more information on MSRs and other retained assets, see “Summary of


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Business Segment Results — Mortgage Banking Segment — Mortgage Servicing Division” and “Summary of Business Segment Results — Thrift Segment — Mortgage-Backed Securities Division.”
 
Management does not believe that any of its off-balance sheet arrangements have or are reasonably likely to have a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
 
AGGREGATE CONTRACTUAL OBLIGATIONS
 
The following summarizes our material contractual obligations as of December 31, 2007 (dollars in thousands):
 
                                                 
    Payment Due(4)  
          January 1,
    January 1,
    January 1,
             
          2008
    2009
    2011
             
          through
    through
    through
    After
       
    Note
    December 31,
    December 31,
    December 31,
    December 31,
       
    Reference     2008     2010     2012     2012     Total  
 
Deposits Without a Stated Maturity
    9     $ 2,488,855     $     $     $     $ 2,488,855  
Custodial Accounts and Certificates of Deposits
    9       15,085,947       189,649       50,665       127       15,326,388  
FHLB Advances
    10       3,584,000       4,236,000       2,594,800       774,000       11,188,800  
HELOC Notes(1)
    11                         212,747       212,747  
Trust Preferred Debentures
    11                         414,285       414,285  
Accrued Interest Payable
          238,458                         238,458  
Deferred Compensation
          41,100       3,343       3,674       4,936       53,053  
Operating Leases(2)
    20       51,536       85,052       57,255       71,594       265,437  
Employment Agreements(3)
          8,431       14,072       6,716             29,219  
Purchase Obligations
          6,841       8,652       1,495             16,988  
                                                 
Total
          $ 21,505,168     $ 4,536,768     $ 2,714,605     $ 1,477,689     $ 30,234,230  
                                                 
 
 
(1) HELOC notes are non-recourse and secured by AAA-rated HELOC certificates.
 
(2) Total lease commitments are net of sublease rental income.
 
(3) With the exception of our Chief Executive Officer, the amounts represent compensation for ten senior executives and include both base salary and estimated bonuses, calculated based on the terms in their respective written employment agreements. According to our Chief Executive Officer’s employment agreement, his bonus is contingent upon our future financial performance and cannot be reasonably estimated for future years. As a result, only his base salary and his actual 2007 bonus to be paid in 2008 are included above.
 
(4) The payment amounts represent those amounts contractually due to the recipient and do not include any unamortized premiums or discounts, hedge basis adjustments, or other similar carrying value adjustments.
 
The following schedule presents significant commitments at December 31, 2007 (dollars in thousands):
 
         
    Payment Due  
 
Undisbursed loan commitments:
       
Reverse mortgages
  $ 349,208  
Builder construction
    465,688  
Consumer construction
    1,148,188  
HELOCs
    1,573,522  
Revolving warehouse lending
    379,037  
Stand-By Letters of credit
    4,308  


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At December 31, 2007, there were no loan purchase commitments under our clean-up call rights. See “Note 20 — Commitments and Contingencies” in the accompanying notes to consolidated financial statements for further details of our clean-up call rights.
 
In connection with standard representations and warranties on loan sales and securitizations, we are occasionally required to repurchase loans or make certain payments to settle claims based on breaches of these representations and warranties. In 2007, our active mortgage banking operations have sold $71.2 billion in loans and repurchased $613 million loans, or 0.86% of total loans sold. To provide for probable losses related to loans sold, we established a reserve based on estimated losses on actual pending and expected claims and repurchase requests, historical experience, loan sales volume and loan sale distribution channels and the assessment of the probability of vendor or investor claims, which is included in “Other liabilities” on the consolidated balance sheets. The balance in this reserve totaled $179.8 million at December 31, 2007. For further information, see “Consolidated Risk Management Discussion — CAMELS Framework for Risk Management — Asset Quality — Secondary Market Reserve.”
 
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
 
RISKS RELATED TO OUR BUSINESS GENERALLY
 
The continuation of current market conditions could adversely impact our business.
 
Our business is affected, directly and indirectly, by domestic and international economic and political conditions and by governmental monetary and fiscal policies. Conditions such as inflation, recession, real estate values, unemployment, volatile interest rates, government monetary policy, and other factors beyond our control may adversely affect our results of operations. Adverse economic conditions could result in an increase in loan delinquencies, foreclosures and nonperforming assets and a decrease in the value of property or other collateral which secures our loans, all of which could adversely affect our results of operations.
 
In 2007, a significant disruption in global credit and housing markets throughout the United States culminated in an industry-wide increase in borrowers unable to make their mortgage payments and increased delinquency and foreclosure rates. Lenders in certain sections of the housing and mortgage markets were forced to close or limit their operations. In response, financial institutions, including Indymac, have tightened their underwriting standards, limiting the availability of sources of credit and liquidity to consumers. Any continued economic slowdown or recession may be accompanied by a further decreased demand for consumer credit, decreased real estate values, and increased rates of delinquencies, defaults and foreclosures. In addition, mortgage loans we originate during an economic slowdown may not be as valuable to us because potential purchasers of our mortgage loans might reduce the premiums they pay for the mortgage loans to compensate for any increased risk arising during such periods. Any sustained increase in delinquencies, defaults or foreclosures is likely to significantly harm the pricing of our future mortgage loan sales and also our ability to finance our mortgage loan originations. If these negative market conditions become more widespread or continue for a prolonged period of time, our earnings and capital could be negatively impacted.
 
Current and anticipated deterioration in the housing market and the homebuilding industry may lead to increased loss severities and further worsening of delinquencies and non-performing assets in our loan portfolios. Consequently, our results of operations may be adversely impacted.
 
Recently, the housing and the residential mortgage markets have experienced a variety of difficulties and changed economic conditions. If market conditions continue to deteriorate beyond what is anticipated in our loss models, they may lead to additional losses in our loan portfolio and real estate owned as we continue to reassess the market value of our loan portfolio, the loss severities of loans in default, and the net realizable value of real estate owned.
 
The homebuilding industry has experienced a significant and sustained decline in demand for new homes and an oversupply of new and existing homes available for sale in various markets, including the ones in which we lend through our homebuilder division. Our builders/borrowers face a greater difficulty in selling their homes in markets where these trends are more pronounced. We do not anticipate that the housing market will improve in the near-


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term. Accordingly, additional downgrades, provisions for loan losses and charge-offs relating to this loan portfolio may occur.
 
The current dislocations in the mortgage market, and the current weakness in the broader financial markets, could adversely affect us.
 
From 2004-2006, the mortgage market was characterized by increased competition for loans and customers which simultaneously lowered profit margins on loans and caused lenders to be more aggressive in making loans to relatively less qualified customers. By the end of 2006, the sustained pricing competition and higher risk portfolios of loans reduced the appetite for loans among whole loan buyers, who offered increasingly lower prices for loans, thereby shrinking profit margins. In addition, the higher levels of credit risk taken on by lenders resulted in higher rates of delinquency in the loans held for investment and in increasing frequency of early payment defaults and repurchase demands on loans that had been sold. These trends accelerated during 2007, and the industry experienced a period of turmoil which has continued into 2008. At the end of 2007, more than 225 mortgage companies operating in the mortgage industry failed and many others faced serious operating and financial challenges.
 
Also, as a result of conditions within the mortgage industry, rating agencies, financial guarantee insurers and investors have recently begun and may continue in the future, to require additional credit enhancements to support the mortgage loans sold into the secondary market. This requirement generally has the effect of reducing our earnings and increasing the overall expense of selling mortgage loans into the secondary market.
 
We may be required to raise capital at terms that are materially adverse to our shareholders.
 
We suffered a loss in excess of $600 million during 2007 and as a result, saw our shareholders’ equity and regulatory capital decline in the second half of the year. While we currently have regulatory capital ratios in excess of the “well capitalized” requirement and have implemented a plan to reduce our balance sheet and increase our capital ratios, there can be no assurance that we will not suffer material losses or that our plans to reduce the balance sheet will succeed. In those circumstances, we may be required to seek additional regulatory capital to maintain our capital ratios at the “well capitalized” level. Such capital raising could be at terms that are very dilutive to existing shareholders and there can be no assurance that any capital raising we undertake would be successful given the current level of disruption in financial markets.
 
We expect to sell a significant portion of our loan production to GSEs and actions by the GSEs could impact our results.
 
Given the disruption in U.S. housing and mortgage markets, the ability to sell mortgages in the private label securitization market is virtually non existent at December 31, 2007. As a result, we have changed our loan production so that a significant majority of our production will be salable to the GSEs. While the GSEs remain active purchasers of loans, they have limited certain types of loans and imposed higher fees on production. There can be no assurance that actions by the GSEs will not have a materially adverse impact on our results and ability to originate loans.
 
A sustained reduction of our mortgage origination volume could harm us financially.
 
The volume of mortgage loans we originate has declined substantially in recent periods. This is a result of decreased demand for mortgage loans by investors, which is primarily the result of increased delinquencies and early payment defaults. Additionally, demand among borrowers for mortgage products has decreased significantly in recent months as the real estate market has experienced significant turmoil. Any sustained period of reduced origination volume is likely to significantly harm our business.
 
Changes in interest rates may adversely affect our business, including net interest income and earnings.
 
Changes in interest rates, including changes in the relationship between short-term rates and long-term rates, may have negative effects on our net interest income and, therefore, our earnings. Changes in interest rates may affect our mortgage banking business in complex and significant ways. For example, changes in interest rates can affect gain on sale on mortgage loans and loan servicing fees, which are the principal components of revenue from sales and servicing of home mortgage loans. When mortgage rates decline, the fair value of MSR assets generally


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declines and gain from mortgage loans tends to increase, to the extent we are able to sell or securitize mortgage loans in the secondary market. When mortgage rates rise, we generally expect loan volumes and payoffs in our servicing portfolio to decrease. As a result, the fair value of our MSR asset generally increases and gain from mortgage loans decreases. In recent periods, however, declines in general interest rates have not resulted in an increase in prepayment rates, due in part to the reduced liquidity in the mortgage markets making refinancing by borrowers more difficult.
 
Economic downturns or disasters in our principal lending markets, including California, New York, Florida, Washington and New Jersey, could adversely impact our earnings.
 
A majority of our loans are geographically concentrated in certain states, including California, New York, Florida, Washington and New Jersey, with 38% of our loans receivable balance at December 31, 2007 being in California. Any adverse economic conditions in these markets, including a continued downturn in real estate values, will likely cause the number of loans acquired to decrease resulting in a corresponding decline in revenues and an increase in the overall credit risk in our loan portfolios. Also, we could be adversely affected by business disruptions triggered by natural disasters or acts of war or terrorism in these geographic areas.
 
Actions undertaken by current and potential competitors could adversely impact our earnings and financial position.
 
While the current disruptions in the housing and credit markets have reduced the number of competitors, we still face significant competition for lending volume. Many of our competitors are larger and enjoy both financial and customer awareness advantages over us. In addition, the reduction in salability of many mortgages has caused us to temporarily discontinue certain lending products that many of our competitors are able to originate.
 
While we believe that our current plans and strategies will allow us to compete in the market, there can be no assurance that we will succeed and as a result, our financial results could be materially worse than we expect.
 
We are subject to changing government laws and regulations, which could adversely affect our operations.
 
The banking industry, in general, is heavily regulated. As a savings and loan holding company, we are subject to regulation by the OTS, and Indymac Bank is subject to regulation by the OTS and the Federal Deposit Insurance Corporation (“FDIC”). The economic and political environment influence regulatory policies, and as such, any or all of our business activities are subject to change if and when our primary regulators change the policies and regulations. As a result of recent negative publicity surrounding the mortgage industry, politicians and regulators are likely to impose additional laws, rules and regulations that could adversely affect our operations. Several pieces of legislation are under consideration at both the federal and state levels that could affect the ways in which we make loans, as well as the ways in which we are able to proceed against delinquent borrowers. Our business is subject to the laws, rules and regulations of various federal and state government agencies. These laws, rules and regulations, among other things, limit the interest rates, finance charges and other fees we may charge, require us to make extensive disclosure and prohibit discrimination. We also are subject to inspection by the OTS and the FDIC. The federal regulations also have been revising the risk-based capital rules, and the results of these revisions may affect our lending business or our competitive position relative to large mortgage lenders.
 
Our business is also subject to laws, rules and regulations regarding the disclosure of non-public information about our customers to non-affiliated third parties. Our operations on the Internet are not currently subject to direct regulation by any government agency in the United States beyond OTS regulations and regulations applicable to businesses generally. A number of legislative and regulatory proposals currently under consideration by federal, state and local governmental organizations may lead to laws or regulations concerning various aspects of business on the Internet, including: user privacy, taxation, content, access charges, liability for third-party activities, and jurisdiction. The adoption of new laws or a change in the application of existing laws may decrease the use of the Internet, increase our costs or otherwise adversely affect our business.
 
Regulatory and legal requirements are subject to change. If such requirements change and become more restrictive, it would be more difficult and expensive for us to comply and could affect the way we conduct our business, which could adversely impact our operations and earnings.


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Our financial condition and results of operations are reported in accordance with GAAP. While not impacting economic results, future changes in accounting principles issued by the Financial Accounting Standards Board could impact our earnings as reported under GAAP. As a public company, we are also subject to the corporate governance standards set forth in the Sarbanes-Oxley Act of 2002, as well as applicable rules and regulations promulgated by the SEC and the New York Stock Exchange. Complying with these standards, rules and regulations may impose administrative costs and burdens on us.
 
Additionally, political conditions could impact our earnings. Acts or threats of war or terrorism, as well as actions taken by the U.S. or other governments in response to such acts or threats, could impact business and economic conditions in which we operate.
 
Our business is highly dependent upon technology for execution of our business model.
 
Our business performance is highly dependent on solidly executing our mortgage banking business model. We must properly price and continue to expand our products, customer base and market share. In addition, the execution of our hedging activities is critical as we have significant exposure to changes in interest rates.
 
We are highly dependent on the use of technology in all areas of our business and we must take advantage of advances in technology to stay competitive. There are no guarantees as to our degree of success in anticipating and taking advantage of technological advances or that we will be more successful in the use of technology than our competitors.
 
Our business process outsourcing and information technology outsourcing activities in India may be adversely impacted by instability in the Indian business environment caused by political factors or data security breaches involving outsourcing firms.
 
Through the Global Resources program, we utilize an off-shore workforce in India predominantly in non-customer-facing back office functions to enhance service levels and improve efficiencies. Political instability, increasing labor disputes and public uprisings may cause disruptions to the general business environment in India. We do not believe these issues should materially impact our outsourcing activities. However, if political and social unrest in India dramatically worsens, our outsourcing activities may be adversely impacted.
 
Additionally, there have been reported incidences of alleged security breaches and loss of customer data involving the outsourcing industry in India. While we have not been affected by any such security breaches and we believe our overall information security framework is very solid, we cannot guarantee that all potential security risks abroad have been eliminated.
 
We may be affected by the further right-sizing of our workforce.
 
During 2007, we reduced our workforce by roughly 1,600 staff through a successful voluntary resignation program, targeted layoffs and eliminations of various outsourced and temporary personnel. In January 2008, Indymac announced further reductions of roughly 2,400 staff. These reductions have been spread throughout the Company’s global workforce. We anticipate additional staff reductions of 500 to 1,000 in the first half of 2008. We believe rightsizing of our workforce is not unusual due to the unprecedented disruption of the mortgage market. However, should this rightsizing hinder our ability to retain or attract talented employees, it may have a negative effect on our business and operating results.
 
RISKS RELATED TO OUR INTEREST RATE HEDGING STRATEGIES
 
Certain hedging strategies that we use to manage our assets and liabilities may be ineffective to mitigate the impact of interest rate changes.
 
We utilize various hedging strategies to mitigate the interest rate risk and prepayment risk inherent in many of our assets, including our mortgage pipeline, our portfolio of interest-only securities, our mortgage servicing rights portfolio, and other financial instruments in which we invest.
 
Due to the characteristics of our financial assets and liabilities and the nature of our business activities, our liquidity, financial position, and results of operations may be materially affected by changes in interest rates in various ways. The objective of our hedging strategies is to mitigate the impact of interest rate changes, on an


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economic and accounting basis, on net interest income and the fair value of our balance sheet. The overall effectiveness of these hedging strategies is subject to market conditions, the quality of our execution, the accuracy of our asset valuation assumptions and other sources of interest rate risk discussed further below.
 
Certain hedging strategies that we use to manage our mortgage pipeline may be ineffective to mitigate the risk of overall changes in fair value of loans held for sale and interest rate lock commitments.
 
The mortgage pipeline consists of our commitments to purchase mortgage loans, or interest rate locks, and funded mortgage loans that will be sold in the secondary market. The risk associated with the mortgage pipeline is that interest rates will fluctuate between the time we commit to purchase a loan at a pre-determined price, or the customer locks in the interest rate on a loan, and the time we sell or commit to sell the mortgage loan. These commitments are managed net of the anticipated loan funding probability, or fallout factor. Generally speaking, if interest rates increase, the value of an unhedged mortgage pipeline decreases, and gain on sale margins are adversely impacted. Typically, we hedge the risk of overall changes in fair value of loans held for sale by either entering into forward loan sale agreements, selling forward Fannie Mae or Freddie Mac MBS or using other derivative instruments to hedge loan commitments and to create fair value hedges against the funded loan portfolios. If the hedging strategies we use to mitigate interest rate risk in our mortgage pipeline are ineffective, our gain on sale margins may be compressed and our earnings may be adversely impacted.
 
Certain hedging strategies that we use to manage our investment in Mortgage Servicing Rights and other retained assets may be ineffective to mitigate the risk of changes in the fair value of these assets due to changes in interest rates.
 
We invest in MSRs and other retained assets to support our mortgage banking strategies and to deploy capital at acceptable returns. The value of these assets and the income they provide tend to be counter-cyclical to the changes in production volumes and gain on sale of loans that result from changes in interest rates. We also enter into derivatives and other mortgage-related securities to hedge our MSRs and other retained assets to offset losses in fair value resulting from increased prepayments in declining interest rate environments. The primary risk associated with MSRs and other retained assets are that they will lose a substantial portion of their value as a result of higher than anticipated prepayments occasioned by declining interest rates. Conversely, these assets generally increase in value in a rising rate environment. Our hedging strategies are highly susceptible to prepayment risk, basis risk, market volatility and changes in the shape of the yield curve among other factors. In addition, our hedging strategies rely on assumptions and projections regarding our assets and general market factors. If these assumptions and projections prove to be incorrect or our hedging strategies do not adequately mitigate the impact of changes in interest rates or prepayment speeds, we may incur losses that could adversely impact our earnings.
 
Certain hedging and asset/liability management strategies that we use to manage our other financial instruments may be ineffective to mitigate the risk of interest rate fluctuations.
 
Certain other financial instruments that we invest in tend to decrease in value as interest rates increase and tend to increase in value as interest rates decline. These include fixed rate mortgage loans held for investment, fixed rate investment grade and non-investment grade mortgage-backed and asset-backed securities. To a lesser extent, adjustable mortgage loans held for investment and mortgage securities supported by adjustable rate mortgage loans may change in value as interest rates change, if the timing or absolute level of interest rate adjustments on the underlying loans do not correspond to applicable changes in market interest rates. We invest in these assets to earn stable spread income. Such assets are subject to interest rate risk because actual future cash flows may vary from expected cash flows primarily due to borrower prepayment behavior.
 
We use hedging and asset/liability management strategies to mitigate the impact that changes in interest rates will have on these financial instruments. These strategies require us to make certain assumptions and use estimates that may prove to be incorrect and make these strategies ineffective to mitigate the interest rate risk embedded in these financial instruments. If these strategies are ineffective our net interest income and earnings may be adversely impacted.


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There can be no assurance that our interest rate risk strategies or their implementation will be successful in any particular interest rate environment.
 
We seek to mitigate our interest rate risks through the various strategies described above. However, there can be no assurance that these strategies (including assumptions concerning the correlation thought to exist between different types of instruments) or their implementation will be successful in any particular interest rate environment, as market volatility cannot be predicted.
 
The following are the primary sources of risk that we must manage in our hedging strategies:
 
Basis Risk.  In connection with our interest rate risk management, basis risk is most prevalent in our hedging activities, in that the change in value of hedges may not equal or completely offset the change in value of the financial asset or liability being hedged. While we choose hedges we believe will correlate effectively with the hedged asset or liability under a variety of market conditions, there are no assurances that the hedges we choose will be perfectly correlated with the assets or liabilities we attempt to hedge. Further, we make assumptions in our financial models as to how LIBOR/swap, treasury, agency and private-label mortgage rates, and other hedges that we might use will change in relation to one another. From time to time, in certain interest rate environments, the relative movement of these different interest rates and the corresponding change in value of the applicable hedge instruments do not change in accordance with our assumptions, which may result in an imperfect correlation between the values of the hedges and the hedged assets making our hedges ineffective in mitigating basis risk which may result in our earnings being adversely impacted.
 
Options Risk.  An option provides the holder the right, but not the obligation, to buy, sell, or in some manner alter the cash flows of an instrument or financial contract. Options may be stand-alone instruments, such as exchange-traded options and over-the-counter contracts, or they may be embedded within standard instruments. Instruments with embedded options include bonds and notes with call or put provisions, loans that give borrowers the right to prepay balances, and adjustable rate loans with interest rate caps or floors that limit the amount by which the rate may adjust. Loans that give borrowers the right to prepay balances present the most significant option risk that we must manage. There are no assurances that the hedges that we select for any type of option will effectively offset the interest rate risks.
 
Repricing Risk.  Repricing risks arise from the timing difference in the maturity and/or repricing of assets, liabilities and off-balance sheet positions. While such repricing mismatches are fundamental to our business, they can expose us to fluctuations in income and economic value as interest rates vary. We monitor and manage repricing risk by calculating and monitoring the duration gap on our individual positions and in the aggregate, and maintaining certain risk tolerances. In certain circumstances, however, this internal risk management process may not eliminate repricing risk. If we inadequately manage our repricing risk through our hedging strategies, our operations and earnings may be adversely impacted.
 
Yield Curve Risk.  The value of certain loans, securities and hedges we hold is based on a number of factors, including the shape or slope of the appropriate yield curve, as the market values of financial assets and hedge instruments are based on expectations for interest rates in the future. Yield curves typically reflect the market’s expectations for future interest rates. In valuing our assets and related hedge instruments, in formulating our hedging strategies and in evaluating the interest rate sensitivity for risk management purposes, our models use market yield curves, which are constantly changing. If the shape or slope of the market yield curves changes unexpectedly, the market values of our assets and related hedges may be negatively impacted and/or changes in the value of the hedges may not be effectively correlated with the changes in the value of the hedged assets or liabilities.
 
RISKS RELATED TO OUR VALUATION OF ASSETS
 
We use estimates in determining the fair value of certain assets, such as Mortgage Servicing Rights, AAA-rated and agency interest-only securities, non-investment grade securities, and residual securities. If our estimates prove to be incorrect, we may be required to write down the value of these assets which could adversely impact our earnings.
 
We hold assets that we retain in connection with the sale or securitization of mortgage loans, including MSRs, AAA-rated and agency interest-only securities, prepayment penalty securities, non-investment grade securities and


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residuals. We use third party vendor financial models to value each of the asset types referred to above. These models are complex and use asset specific collateral data and market inputs for interest rates. In addition, the modeling requirements of MSRs and residual securities are significantly more complex than those of AAA-rated and agency interest-only securities because of the high number of variables that drive cash flows associated with MSRs and the complex cash flow structures, which may differ on each securitization, that determine the value of residual securities. There are no assurances that we can properly manage the increased complexity of our models and valuations to ensure, among other things, that the models are properly calibrated, the assumptions are reasonable, the mathematical relationships used in the model are predictive and remain so over time, and the data and structure of the assets and hedges being modeled are properly input.
 
Even if the general accuracy of the valuation model is validated, valuations are highly dependent upon the reasonableness of our assumptions and the predictability of the relationships which drive the results of the model. Such assumptions are complex as we must make judgments about the effect of matters that are inherently uncertain. As the number of variables and assumptions affecting the possible future resolution of the uncertainties increases, those judgments become even more complex. If loans in our investment portfolio, or loans underlying certain assets in our investment portfolio prepay faster than estimated or loan loss levels are higher than anticipated, we may be required to write down the value of certain assets which could adversely impact our earnings.
 
Our valuation assumptions regarding securities acquired from third party issuers may be incorrect, which could adversely impact our earnings.
 
From time to time, we may acquire securities from third party issuers. We value these securities with complex financial models that incorporate significant assumptions and judgments, which could vary significantly as market conditions change. If our assumptions with respect to these types of assets are incorrect, we may be required to write down the value of some or all of these assets which could adversely impact our earnings.
 
RISKS RELATED TO OUR ASSUMPTION OF CREDIT RISK
 
The rate of loan losses we incur may exceed the level of our loss reserves, which could adversely impact our earnings.
 
We establish reserves for various credit risk exposures. These reserves are often based on estimates of borrower behavior and the value of underlying collateral. Both our business units and corporate oversight groups review the adequacy of these reserves and the underlying estimates on a periodic basis and we make adjustments to the reserves when required. There is no assurance that our actual losses will not exceed our estimates and adversely impact our earnings.
 
We hold in our portfolio a significant number of builder construction loans, which may pose more credit risk than other types of mortgage loans typically made by savings institutions.
 
We ceased offering residential construction loans for builders and developers. Builder construction loans are considered more risky than other types of residential mortgage loans. Due to the disruptions in credit and housing markets, many of the builders we lend to experienced a dramatic decline in sales of new homes from their projects. As a result of this unprecedented market disruption, a significant portion of our builder construction portfolio is expected to become non-performing as builders are unable to sell homes in volumes large enough for orderly repayment of loans.
 
While we believe we have established adequate reserves on our financial statements to cover the credit risk of our builder construction loan portfolio, there can be no assurance that losses will not exceed our reserves, which could adversely impact our earnings. Given the current environment we expect that the non-performing loans in our builder construction portfolio will increase substantially and these non-performing loans could result in a material level of charge-offs that will negatively impact our earnings, liquidity and capital. Our failure to adequately address the related risks could have an adverse effect on our business and results of operations.


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Our risk management policies and practices may not adequately manage our exposure to credit risk in our business operations.
 
We have assumed a degree of credit risk in connection with our investments in certain mortgage securities and loans held for investment and sale, as well as in connection with our construction lending operations and our mortgage banking activities. We have established risk management and credit polices to manage our exposure to credit losses in each of these business operations. We have also established a central credit risk management group to monitor the credit quality of our balance sheet and production. We cannot be sure, however, that the risk management polices and practices in place will provide adequate oversight of our credit risk.
 
Our earnings could be adversely impacted if the assumptions underlying our risk-based pricing models prove to be incorrect.
 
Our mortgage loan underwriting process, including our e-MITS underwriting and pricing system, depends heavily on risk-based pricing models. Our risk-based pricing models, including the risk-based pricing models utilized in e-MITS, are based primarily on standard industry loan loss data supplemented by our historical loan loss data and proprietary logic developed by us. Because the models cannot predict the effect of financial market and other economic performance factors, there are no assurances that our risk-based pricing models are a complete and accurate reflection of the risks associated with our loan products which may reduce the quality of our loan portfolio and could adversely impact our earnings.
 
We are exposed to credit risk related to counterparties in many of our businesses. If these counterparties are unable to perform according to the terms of our contract, our earnings may be adversely impacted.
 
In connection with our trading and hedging activities, we do business only with counterparties that we believe are established and sufficiently capitalized. In addition, with respect to hedging activities on the pipeline of mortgage loans held for sale, we enter into “master netting” agreements with the Fixed Income Clearing Corporation, an independent clearinghouse. This entity collects and pays daily margin deposits to reduce the risk associated with counterparty credit quality. We do not engage in any foreign currency trading. All interest rate hedge contracts are with entities (including their subsidiaries) that are approved by a committee of our Board of Directors and that generally must have a long term credit rating of “A” or better (by one or more nationally recognized statistical rating organization) at the time the relevant contract is consummated.
 
Our earnings could be adversely impacted by incidences of fraud and compliance failures that are not within our direct control.
 
We are subject to fraud and compliance risk in connection with the purchase or origination of mortgage loans. Fraud risk includes the risk of intentional misstatement of information in property appraisals or other underwriting documentation provided to us by third parties. This risk is typically higher in the acquisition of a loan from a third-party seller. Compliance risk is the risk that loans are not originated in compliance with applicable laws and regulations, and to our standards. There can be no assurance that we can prevent or detect acts of fraud or violations of law or our compliance standards by third parties that we deal with. Frequent incidences of fraud or violations of law or our compliance standards may require us to repurchase loans that we have originated and sold at a more frequent rate than we have anticipated and could have an adverse impact on our earnings.
 
We are exposed to credit risk from the sale of mortgage loans.
 
We retain limited credit exposure from the sale of mortgage loans. We make standard representations and warranties to the transferee in connection with all such dispositions. These representations and warranties do not assure against credit risk associated with the transferred loans, but if individual mortgage loans are found not to have fully complied with the associated representations and warranties we have made to a transferee, we may be required to repurchase the loans from the transferee or we may make payments in lieu of curing such breaches of these representations and warranties. Given the significant delinquencies in higher CLTV/LTV products, we expect that claims for repurchases pursuant to contractual representation and warranties will increase. While we have established reserves for what we consider as probable and reasonably estimable losses, there can be no assurance that losses will not ultimately exceed our reserves and materially impact future results.


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Our management of the credit risk associated with non-investment grade MBS and residual securities depend upon estimates and assumptions that may not be accurate.
 
We assume a certain degree of credit risk in connection with investments in non-investment grade MBS and residual securities that we occasionally acquire from third-party issuers or retain from our own securitizations. Non-investment grade securities (rated below BBB) may or may not represent the second loss position, depending on the rating, but are typically subject to a disproportionate amount of the credit risk. Residuals represent the first loss position and are not typically rated by a nationally recognized rating agency. In general, non-investment grade securities bear losses prior to the more senior investment grade securities, and therefore bear a disproportionate amount of the credit risk with respect to the underlying collateral.
 
Non-investment grade securities represent leveraged credit risk as they absorb a disproportionate share of credit risk as compared to investment grade securities. These securities are recorded net of discount that is based upon, among other things, the estimated credit losses, expected prepayments, as estimated by internal loss models and/or perceived by the market, and the coupons, associated with these securities. The adequacy of this discount is dependent upon how accurate our estimate is of both the amount and timing of the cash flows paid to the non-investment grade securities, which is primarily based upon our estimate of the amount and timing of credit losses and prepayments on the underlying loan collateral.
 
Residual securities possess a greater degree of risk because they are relatively illiquid, represent the first loss position and require a higher reliance on financial models in determining their fair value. Realization of this fair value is dependent upon the accuracy of our estimate of both the amount and timing of the cash flows paid to the residual securities, which are based primarily on our estimate of the amount and timing of credit losses on the underlying loan collateral and to a lesser extent prepayment rates on the underlying loan collateral.
 
If we do not adequately estimate the credit losses, prepayments and the amount and timing of cash flows associated with non-investment grade and residual securities that we hold, our earnings and cash flows may be adversely impacted.
 
RISKS RELATED TO OUR LIQUIDITY
 
If current market conditions persist, our ability to increase liquidity, including through the sale of mortgage loans in the secondary market or otherwise, could be limited, which could adversely affect our earnings.
 
Our liquidity may be affected by an inability to access the capital markets, which may arise due to circumstances beyond our control, such as general market disruption. During 2007, and continuing into 2008, there has been significant volatility in the mortgage market, including non-conforming residential mortgages. Since the second quarter of 2007, liquidity in the secondary market for nonconforming residential mortgages and securities backed by such loans has diminished significantly. While these market conditions persist, our ability to increase liquidity through the sale of mortgage loans in the secondary market will be adversely affected. We cannot predict with any degree of certainty how long these market conditions may continue or whether liquidity for nonconforming residential mortgages will improve.
 
Our ability to borrow funds and raise capital could be limited, which could adversely affect our earnings.
 
We have significant sources of liquidity as a result of our federal thrift structure. During 2007, we paid off all of our borrowings under reverse repurchase facilities and asset backed commercial paper facilities as market conditions made the cost and availability of funds from these facilities more onerous. We significantly increased our deposits and as of December 31, 2007, our only significant borrowings were from the FHLB, deposits and long term liabilities. As a thrift, we also have access to significant liquidity from the Federal Reserve Discount Window, although we have not utilized that facility. In order to further reduce our risk and strengthen our liquidity, we focus our deposit gathering on deposits that are fully insured by the FDIC. We estimate that approximately 95% of all deposits are fully insured. While our sources of liquidity are strong and have been stable throughout this current market disruption, there can be no assurance that actions by the FHLB or the Federal Reserve would not reduce our borrowing capacity or that we would be unable to attract deposits at competitive rates. Such events could have a material adverse impact on our results of operations and financial condition.


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Additionally, we are required to maintain adequate capital by the OTS. There is no guarantee that we will be able to adequately access capital markets when or if a need for additional capital arises which could limit our ability to increase the assets on our balance sheet and adversely impact our earnings.
 
The accumulation of MSRs is a large component of our strategy. As of December 31, 2007, the capitalized value of MSRs was $2.5 billion. OTS regulations effectively impose higher capital requirements on the amount of MSRs that exceeds total Tier 1 capital. These higher capital requirements could result in lowered returns on our retained assets and could limit our ability to retain servicing assets and even cause our capital levels to decline significantly if the value of our MSRs grows. While management believes that compliance with the capital limits on MSRs will not materially impact future results, no assurance can be given that our plans and strategies will be successful.
 
Significant illiquidity, volatility and spread widening (i.e., an increase in credit risk premiums required by investors between mortgage-backed securities and comparable duration Treasury securities) in the secondary markets could have a material adverse impact on our mortgage production earnings and the earnings of the Company overall.
 
We rely heavily on the secondary markets, having sold 25% of the loans we sold in the fourth quarter of 2007 and 34% of the loans we sold in the year ended December 31, 2007 in private label securitizations, and 0% and 18% for the same periods, respectively, to whole loan investors. The secondary markets are currently experiencing mortgage spread widening and reduced liquidity, and this could continue or worsen in the future. One factor contributing greatly to secondary market uncertainty at present is uncertainty with respect to potential actions to be taken by the major agencies who rate mortgage-backed securities (Standard and Poor’s, Moody’s and Fitch). The agencies have recently downgraded many securities, announced that others are under review and stated that they are reviewing their models for determining subordination levels given mortgage industry credit deterioration, which will likely result in increased subordination levels and, therefore, increased mortgage credit costs for borrowers.
 
Spread widening can be severe and happen abruptly, as has happened recently. Indymac hedges the interest rate risk inherent in our pipeline of mortgage loans held for sale and rate-locked loans in process to protect our MBR margins. We attempt to hedge the type of spread widening caused by the secondary market disruptions we have experienced in 2007. Severe and abrupt spread widening, as we have recently experienced, can have a material adverse impact on our near-term earnings. Given the current uncertainties and resulting volatility in the secondary market, the risk of further spread widening must be considered significant, and our hedging activities may not be effective.
 
Illiquidity in the secondary market at present means that with respect to private label securitizations, there is reduced investor demand for mortgage-backed securities. Illiquidity is also reducing demand from whole loan investors. Under these conditions, we use our capital capacity and liquidity to hold increased levels of both securities and loans. While our capital and liquidity positions are currently strong, our capacity to retain loans and securities on our balance sheet is not unlimited. A prolonged period of secondary market illiquidity could result in us having to implement further mortgage guideline tightening, which would result in lower mortgage production volumes. This could have a material adverse impact on our future earnings.
 
CRITICAL ACCOUNTING POLICIES AND JUDGMENTS
 
Several of the critical accounting policies important to the portrayal of our financial condition and results of operations require management to make difficult and complex judgments that rely on estimates about the effect of matters that are inherently uncertain due to the impact of changing market conditions and/or consumer behavior. We believe our most critical accounting policies relate to: (1) assets that are highly dependent on internal valuation models and assumptions rather than market quotations, including MSRs and non-investment grade securities and residuals; (2) derivatives and other hedging instruments; (3) allowance for loan losses (“ALL”); (4) loans held for sale, including estimates of fair value, LOCOM valuation reserve and sale accounting treatment; and (5) secondary market reserve.
 
Management discusses these critical accounting policies and related judgments with Indymac’s Audit Committee and external auditors on a regular basis. We believe the judgments, estimates and assumptions used in the preparation of our consolidated financial statements are appropriate given the factual circumstances at the


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time. However, given the sensitivity of our consolidated financial statements to these critical accounting policies, the use of other judgments, estimates and assumptions could result in material differences in our results of operations or financial condition. Our accounting policies are described in “Note 1 — Summary of Significant Accounting Policies.”
 
FAIR VALUE INSTRUMENTS
 
With the exception of the ALL, these items are generally created in connection with our loan sale and securitization process. The allocated cost of the retained assets at the time of the sale is recorded as a component of the net gain (loss) on sale of loans. Such retained assets were comprised of MSRs and to a much lesser degree, AAA-rated agency and non-agency securities, AAA-rated and agency interest-only securities, AAA-rated principal-only securities, prepayment penalty securities, late fee securities, investment grade and non-investment grade securities, and residual securities.
 
Fair values for these assets are determined by using available market information, historical performance of the assets underlying collateral and internal valuation models as appropriate. The reasonableness of fair values will vary depending upon the availability of third party market information, which is a function of the market liquidity of the asset being valued. In connection with our mortgage banking and investment portfolio operations, we invest in assets created from the loan sale and securitization process, for which markets are relatively limited and illiquid. As a result, the valuation of these assets is subject to our assumptions about future events rather than market quotations. These assets generally include MSRs, AAA-rated and agency interest-only securities, non-investment grade securities and residuals. As the number of variables and assumptions used to estimate fair value increases and as the time period increases over which the estimates are made, such estimates will likely change in a greater number of periods, potentially adding volatility to our valuations and financial results. For further information regarding the sensitivity of the fair value of these assets to changes in the underlying assumptions, refer to “Note 13 — Transfers and Servicing of Financial Assets” in the accompanying consolidated financial statements of the Company.
 
We use fair value hedge accounting for a portion of our loans held for sale. There is a risk that at times we might not satisfy the requirements for fair value hedge accounting under SFAS 133, as amended, for a portion of our loans held for sale because we do not meet the required complex hedge correlation tests. This could cause temporary fluctuations in our reported income but not in the ultimate economic results. Any potential fluctuation in our reported results if hedge accounting is not achieved would be over a very short period during 2007 and the economic effect of both the hedges and loans would be recorded once the sale was completed. In addition, any imprecision in valuation of these items would be adjusted and recorded in a short period through our gain (loss) on sale margin once the sale of the loans was completed.
 
MORTGAGE SERVICING RIGHTS
 
MSRs are created on the sale of loans to GSEs, in private-label securitizations, and sometimes, from the sale of whole loans. We also purchase MSRs from time to time from third parties. The carrying value of MSRs in our financial statements represents our estimate of the present value of future cash flows to be received by us as servicer of the loans. In general, future cash flows are estimated by projecting the service fee, plus late fees and reinvestment income associated with interest earned on “float,” after subtracting guarantee fees on agency portfolios, the cost of reimbursing investors for compensating interest associated with the early pay-off of loans, the market cost to service the loans, the cost of mortgage insurance premiums (if applicable), and estimated prepayments.
 
MSRs are recorded at fair value with valuation changes, net of hedges, being reported in “Service fee income” in the consolidated statements of operations. We use option adjusted spread (“OAS”) to determine the fair value of MSRs and benchmark this value to a third party valuation model. The key assumptions include prepayment rates and, to a lesser degree, reinvestment income and discount rates. Based on these assumptions, our model calculates implied discount rates, which we compare to market discount rates and risk premiums to determine if our valuations are reasonable.


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In addition to considering actual prepayment trends, future prepayment rates are estimated based on the following factors:
 
1) Relative Coupon Rate.  The interest rate the borrower is currently paying relative to current market rates for that type of loan is the primary predictor of the borrower’s likelihood to prepay. We assume a borrower’s propensity to prepay increases when the borrower’s loan rate exceeds the current market rates.
 
2) Seasoning.  Based on prepayment curves and other studies performed by industry analysts of prepayment activity over the life of a pool of loans, a pattern has been identified whereby prepayments typically peak in years one to three, consistent with borrower moving habits.
 
3) Seasonality.  Seasonality refers to the time of the year that prepayments occur. All else being constant, prepayments tend to be higher in summer months due to borrowers’ tendency to move outside of the school year and lower in winter months due to the holiday season.
 
4) Burn Out.  Burn out is associated with a pool of mortgage loans which has endured a variety of high prepayment environments such that it may be assumed that the remaining borrowers are insensitive to any subsequent decline in interest rates. Consequently, all else being equal, projected prepayment speeds for such a pool of loans would be lower than a newly originated loan pool with comparable characteristics.
 
As cash flows must be estimated over the life of the pool of mortgage loans underlying the MSRs, assumptions must be made about the level of interest rates over that same time horizon, which is primarily three to five years. We utilize a credit spread over the market LIBOR/interest rate swap forward curve to estimate the level of mortgage interest rates over the life of the pool of loans. We believe a forward curve, as opposed to static or spot interest rates, incorporates the market perception about expected changes in interest rates and provides a more realistic estimate of lifetime interest rates and therefore prepayment rates.
 
The discount rate represents the implicit yield a knowledgeable investor would require to purchase or own the projected cash flows. Using an OAS model, embedded options and other cash flow uncertainties are quantified across a large number of hypothetical interest rate environments. The OAS is essentially the credit spread over the risk free rate after the option costs (e.g., hedge costs) are considered. Overall, we evaluate the reasonableness of the discount rate based on the spread over the risk free rate (duration adjusted LIBOR securities) relative to other cash flow sensitive investments with higher and lower risk profiles.
 
Reinvestment income represents the interest earned on custodial balances, often referred to as float. Custodial balances are generated from the collection of borrower principal and interest and escrow balances which we generally hold on deposit for a short period until the required monthly remittance of such funds to a trustee. Reinvestment income is reduced by compensating interest, or “interest shortfall,” which we must pay to investors to compensate for interest lost on the early payoff of loans pursuant to our servicing obligations. Our estimate of reinvestment income is a function of float, which is derived from our estimate of prepayment speeds, and an estimate of the interest rate we will earn by temporarily investing these balances. The reinvestment rate is typically based on the Federal Funds rate, and we factor in the market forward curve to derive a long-term estimate.
 
The valuation of MSRs includes numerous assumptions of varying lower sensitivities in addition to the assumptions discussed above. For example, other assumptions include, but are not limited to, market cost to service loans, prepayment penalties, delinquencies and the related late fees and escrow balances.
 
NON-INVESTMENT GRADE SECURITIES AND RESIDUALS
 
General
 
Non-investment grade securities and residuals are created upon the issuance of private-label securitizations. Non-investment grade securities (rated below BBB) represent leveraged credit risk as they typically absorb a disproportionate amount of credit losses before such losses affect senior or other investment grade securities. Residuals represent the first loss position and are not typically rated by the nationally recognized agencies. The value of residuals represents the present value of future cash flows expected to be received by us from the excess cash flows created in the securitization transaction. In general, future cash flows are estimated by taking the coupon


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rate of the loans underlying the transaction less the interest rate paid to the investors and contractually specified servicing and trustee fees, and estimated prepayments and credit losses.
 
Cash flows are also dependent upon various restrictions and conditions specified in each transaction. For example, residuals are not typically entitled to any cash flows unless over-collateralization has reached a certain level. The over-collateralization represents the difference between the bond balance and the collateral underlying the security. A sample over-collateralization structure may require 2% of the original collateral balance for 36 months. At month 37, it may require 4%, but on a declining balance basis. Due to prepayments, that 4% requirement is generally less than the 2% required on the original balance. In addition, the transaction may include an over-collateralization “trigger event,” the occurrence of which may require the over-collateralization to be increased. An example of such a trigger event is delinquency rates or cumulative losses on the underlying collateral that exceed stated levels. If over-collateralization targets were not met, the trustee would apply cash flows that would otherwise flow to the residual security until such targets are met. A delay or reduction in the cash flows received will result in a lower valuation of the residual.
 
We consider certain of our investment grade securities to be economic hedges of our non-investment grade securities and residuals. We classify these investment grade securities as trading securities in order to reflect changes in their fair values in our current results. Residuals are generally classified as trading securities so the accounting for these securities will mirror the economic hedging activities. All other MBS, including a portion of our non-investment grade securities, are classified as available for sale. At least quarterly, we evaluate the carrying value of non-investment grade securities and residuals in light of the actual performance of the underlying loans. If fair value is less than amortized cost and the estimated undiscounted cash flows have decreased compared to the prior period, the impairment is recorded through earnings. We classify our non-investment grade residuals as trading and therefore record them at fair value, with changes in fair value being recorded through earnings. We use a third-party model, using the “cash-out” method to value these securities. This method reflects when we receive the cash, which may be later than when the trust receives the cash. The model takes into consideration the cash flow structure specific to each transaction (such as over-collateralization requirements and trigger events). The key valuation assumptions include credit losses, prepayment rates and, to a lesser degree, discount rates.
 
Loss Estimates
 
We use a proprietary loss estimation model to project credit losses. This model was developed utilizing our actual loss experience for prime and subprime loans. The modeling logic has been reviewed by ERM. The expected loan loss is a function of loan amount, conditional default probability and projected loss severity. Characteristics that impact default probability vary depending on loan type and current delinquency status, but generally include the borrower’s credit score, loan-to-value ratio, loan amount, debt-to-income ratio, and loan purpose, among other variables. Characteristics that impact loss severity includes unpaid principal balance, loan-to-value, days to liquidation and mortgage insurance status. The loss estimation model also includes conditional default curves, which relate to the expected timing of the estimated loss. In our experience, default probabilities generally reach a peak within two to three years of loan origination and become less likely after four to five years. While there can be no assurance as to the accuracy of the model in predicting losses, we have “back tested” the model’s default probability logic. The model is updated and recalibrated periodically based on our on-going actual loss experience.
 
Prepayment Speeds
 
We estimate prepayments on a collateral-specific basis and consider actual prepayment activity for the collateral pool. We also consider the current interest rate environment, the market forward curve projections and prepayments estimated on similar collateral pools where we own MSRs. While higher prepayment speeds tend to be closely correlated with a reduced credit environment, increasing prepayments may reduce the value of residual securities since these securities represent excess spread on the underlying collateral. Therefore, higher prepayments, in isolation, reduce the life of the residual and total cash flows resulting in a reduction in the fair value of the residual.


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Discount Rates
 
We determine static discount rates based on a number of factors, including but not limited to the collateral type and quality, structure of the transaction, market interest rates and our ability to generate an appropriate after tax return on equity given the other valuation assumptions and resulting projected cash flows. We also review the discount rates used by other investors for similar securities to evaluate the appropriateness of our assumptions. As non-investment grade securities and residuals are our higher risk assets, and liquidity is generally the lowest for these assets on a duration adjusted basis, the spread over the risk free rate is also the highest of all of our cash flow sensitive assets.
 
DERIVATIVES AND OTHER HEDGING INSTRUMENTS
 
The accounting and reporting standards for derivative financial instruments are established in SFAS 133. SFAS 133 requires that we recognize all derivative instruments on the balance sheet at fair value. The accounting for changes in fair value of these instruments depends on the intended use of the derivative and the associated designation. If certain conditions are met, hedge accounting may be applied and the derivative instrument may be specifically designated as a fair value hedge or a cash flow hedge. In designating hedges of certain funded mortgage loans in our pipeline and our borrowings and advances as fair value hedges and cash flow hedges, respectively, we are required by SFAS 133 to establish at the inception of the hedge the method we will use in assessing the effectiveness of the hedging relationship, for hedge accounting qualification, and in measuring and recognizing hedge ineffectiveness, for financial reporting purposes. In accordance with the requirements of SFAS 133, these methods are consistent with our approach to managing risk.
 
In complying with the requirements of SFAS 133, our management team has made certain judgments in identifying derivative instruments, designating hedged risks, calculating hedge effectiveness, and measuring, recognizing, and classifying changes in value. Critical judgments made with respect to our hedge designations include:
 
  •  Hedge Effectiveness Testing Methodology.  SFAS 133 requires we identify and consistently follow a methodology justifying our expectation that our hedges will continue to be highly effective at achieving offsetting changes in value. In devising such a methodology, which is consistent with our risk management policy, we have exercised judgment in identifying: (1) the scope and the types of historical data and observations; (2) the mathematical formulas and quantitative steps to calculate hedge effectiveness; and (3) the frequency and necessity of updates to our calculations and assumptions. As discussed in the footnotes to our financial statements, we have designated certain forwards, futures, and interest rate swaps to hedge the benchmark interest rate risk in our funded mortgage loan pipeline and borrowings exposures, respectively, as SFAS 133 hedges. If the results of our hedge effectiveness tests determine that our hedges are not effective, we do not adjust the basis of our pipeline mortgage loans, in the case of disqualified fair value hedges, or defer derivative gains and losses in “Other comprehensive income” (“OCI”), in the case of disqualified cash flow hedges, from the date our hedges were last effective to the date they are again compliant with SFAS 133. Therefore, the ability to recognize hedge accounting basis adjustments and OCI deferrals may cause us to report materially different results under different conditions or using different assumptions.
 
  •  Hedge Ineffectiveness Measurement.  Regardless of our method of proving hedge effectiveness, we are required to recognize hedge ineffectiveness in earnings to the extent that exact offset is not achieved, as defined by SFAS 133. As discussed in the footnotes to the financial statements, the estimated fair value amounts of our financial instruments have been determined using available market information and valuation methods we believe are appropriate under the circumstances. These estimates are inherently subjective in nature and involve matters of significant uncertainty and judgment to interpret relevant market and other data. The use of different market assumptions and/or estimation methods may have a material effect on the estimated fair value amounts, and, therefore, on the recognition of basis adjustments and OCI deferrals for hedged mortgage loans and forecasted borrowing/advance cash flows, respectively, as well as the hedge ineffectiveness recognized in the income statement for both hedge types.


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Some of our hedges, including certain elements of our pipeline which are required to be carried at fair value as derivative instruments in accordance with SFAS 133, and other derivative instruments for which we do not designate hedging relationships for accounting purposes, involve estimates of fair value where no direct exchange-traded or indirect “proxy” market prices are immediately available. As noted above and in the footnotes to our financial statements, we employ available market information and valuation methods we believe are appropriate under the circumstances and, as applicable, within the range of industry practice.
 
Changes in either the mix of market information or the valuation methods used would change the fair values carried on the balance sheet, the associated impact on the income statement, and the application and impacts of SFAS 133 hedge accounting.
 
SAB 105 provides guidance regarding loan commitments accounted for as derivative instruments. As noted in the footnotes to the financial statements, interest rate lock commitments are valued at zero at inception in accordance with SAB 105. The rate locks are adjusted for changes in value resulting from changes in market interest rates. SAB 109 supersedes SAB 105 and is effective prospectively for loan commitments issued or modified beginning January 1, 2008. Upon adoption of SAB 109, we will recognize revenue at the inception of a rate lock commitment.
 
Non-derivative contracts sometimes contain embedded terms meeting the definition of a derivative instrument under SFAS 133. In certain circumstances, management has concluded such terms are appropriately excluded from fair value accounting as they are clearly and closely related to the economic characteristics of the non-derivative “host” contract, in accordance with SFAS 133. Under different facts and circumstances, should such embedded terms not be considered clearly and closely related, recognition of such embedded derivatives on the balance sheet at fair value would be required by SFAS 133.
 
ALLOWANCE FOR LOAN LOSSES
 
For the loans held for investment portfolio, an ALL is established and allocated to various loan types. The determination of the level of the ALL and, correspondingly, the provision for loan losses, is based on delinquency trends, prior loan loss experience, and management’s judgment and assumptions regarding various matters, including general economic conditions and loan portfolio composition. Management continuously evaluates these assumptions and various relevant factors impacting credit quality and inherent losses. We utilize several methodologies to estimate the adequacy of our ALL and to ensure the allocation of the ALL to the various portfolios is reasonable given current trends and economic outlook. In this regard, we segregate assets into homogeneous pools of loans and heterogeneous loans.
 
Homogeneous pools of loans exhibit similar characteristics and, as such, can be evaluated as pools of assets through the assessment of default probabilities and corresponding loss severities. Our homogeneous pools include residential mortgage loans, consumer construction loans, HELOCs, closed-end seconds, manufactured home loans and home improvement loans. The estimate of the ALL for homogeneous pools is based on recent product-specific migration patterns and recent loss experience.
 
Our builder construction loans generally carry higher balances and involve unique loan characteristics that cannot be evaluated solely through the use of default rates, loss severities and trend analysis. To estimate an appropriate level of ALL for our heterogeneous loans, we constantly screen the portfolios on an individual asset basis to classify problem credits and to estimate potential loss exposure. In this estimation, we determine the level of adversely classified assets (using the classification criteria described below) in a portfolio and the related loss potential and extrapolate the weighting of those two factors across all assets in the portfolio.
 
Our asset classification methodology was designed in accordance with guidelines established by our supervisory regulatory agencies as follows:
 
  •  Pass — Assets classified Pass are assets that are well protected by the net worth and paying capacity of the borrower or by the value of the asset or underlying collateral.
 
  •  Special Mention — Special Mention assets have potential weaknesses that require close attention, but have not yet jeopardized the timely repayment of the asset in full.


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  •  Substandard — This is the first level of adverse classification. Assets in this category are inadequately protected by the net worth and paying capacity of the borrower or by the value of the collateral. Substandard assets are characterized by the distinct possibility some loss will occur if the deficiencies are not corrected.
 
  •  Doubtful — Assets in this category have the same weaknesses as a substandard asset, with the added characteristic that based on current facts, conditions and values, liquidation of the asset in full is highly improbable.
 
  •  Loss — Assets in the Loss category are considered uncollectible and of such little value that the continuance as an asset, without establishment of a specific valuation allowance, is not warranted.
 
A component of the overall ALL is not specifically allocated (“unallocated component”). The unallocated component reflects management’s assessment of various factors that create inherent imprecision in the methods used to determine the specific portfolio allocations. Those factors include, but are not limited to, levels of and trends in delinquencies and impaired loans, charge-offs and recoveries, volume and terms of the loans, effects of any changes in risk selection and underwriting standards, other changes in lending policies, procedures, and practices, and national and local economic trends and conditions.
 
Impaired loans include loans classified as non-accrual where it is probable we will be unable to collect the scheduled payments of principal and interest according to the contractual terms of the loan agreement. When a loan is deemed impaired, the amount of specific allowance required is measured by a complete analysis of the most probable source of repayment, including the present value of the loan’s expected future cash flows, the fair value of the underlying collateral less costs of disposition, or the loan’s estimated market value. In these measurements, we use assumptions and methodologies that are relevant to estimating the level of impaired and unrealized losses in the portfolio. To the extent the data supporting such assumptions has limitations, our judgment and experience play a key role in enhancing the ALL estimates.
 
We transferred mortgage loans HFS to HFI and recorded a reduction to the net investment, a portion of this reduction represents credit losses we estimated in determining the market value of loans. This amount represents a “reserve” for future realized credit losses. If our estimate of inherent credit losses in the transferred pool increases, we may record a provision for loan losses which will increase the ALL.
 
As the housing and mortgage markets deteriorated during 2007, we made adjustments to key assumptions used to establish our loss reserves. Generally, we adjusted our assumptions as to frequency of mortgage loans moving to default and the expected severities of losses from sales of underlying REO properties. We also adjusted assumptions on our builder construction portfolio to give consideration to the project and market specific condition for loans in this portfolio that have or are expected to default.
 
LOANS HELD FOR SALE
 
Loans held for sale are carried at the lower of aggregate cost, net of purchase discounts or premiums, deferred fees, deferred origination costs and effects of hedge accounting, or fair value. Historically, the fair value of loans held for sale was determined using current secondary market prices for loans with similar coupons, maturities and credit quality. Given recent market disruptions, these current secondary market prices generally relied on to value conditions of the HFS loans were not available. As a result, the Company considered other factors, including: 1) quoted market prices for to be announced (“TBA”) securities (for agency-eligible loans); 2) recent transaction settlements or traded but unsettled transactions for similar assets; 3) recent third party market transactions for similar assets; and 4) modeled valuations using assumptions the Company believes a reasonable market participant would use in valuing similar assets (assumptions may include loss rates, prepayment rates, interest rates, volatilities, mortgage spreads). At December 31, 2007, the majority of the Company’s loans HFS are GSE-eligible. As these loans have reliable market price information, the fair value of these loans continues to be based on quoted market prices of similar assets. For the non GSE-eligible loans, including loans transferred to HFI at the lower of cost or fair value, the valuation of these loans requires more reliance on recent third party market transactions for similar assets and modeled valuations using assumptions the Company believes a reasonable market participant would use in valuing similar assets.


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Since there was very limited available price discovery due to the collapse of the secondary market for non-GSE mortgages, the estimation of fair value in the second half of 2007 required significant management judgment.
 
While management believes its determination of fair values is reasonable in the circumstances, even small changes in the underlying assumptions, application of different valuation approaches or a different assessment of the weight of evidence from the available sources of information could have resulted in significantly different estimates.
 
Our recognition of gain or loss on the sale of loans is accounted for in accordance with SFAS 140. Typically, we structure such transfers to meet the sale accounting criteria as set forth in SFAS 140 and record the commensurate gain on sale. SFAS 140 requires a transfer of financial assets in which we surrender control over the assets be accounted for as a sale to the extent that consideration, other than beneficial interest in the transferred assets, is received in exchange. The carrying value of the assets sold is allocated between the assets sold and the retained interest based on their relative fair values.
 
SFAS 140 requires, for certain transactions completed after the initial adoption date, a “true sale” analysis of the treatment of the transfer under state law as if we were a debtor under the bankruptcy code. A “true sale” legal analysis includes several legally relevant factors, such as the nature and level of recourse to the transferor and the nature of retained servicing rights. The analytical conclusion as to a “true sale” is never absolute and unconditional, but contains qualifications based on the inherent equitable powers of a bankruptcy court, as well as the unsettled state of the common law. Once the legal isolation test has been met under SFAS 140, other factors concerning the nature and extent of the transferor’s control over the transferred assets are taken into account in order to determine whether derecognition of assets is warranted, including whether the special-purpose entity has complied with rules concerning qualifying special-purpose entities.
 
SECONDARY MARKET RESERVE
 
As part of the normal course of business involving loans sold to the secondary market, we can be required to repurchase loans or make payments to settle breaches of the standard representations and warranties made as part of our loan sales or securitizations. We can be required to repurchase loans from investors when our loan sales contain individual loans that do not conform to the representations and warranties we made at the time of sale (including early payment default provisions). We maintain a secondary market reserve for losses that arise in connection with loans that we may be required to repurchase from whole loan sales, sales to the GSEs, and securitizations. The reserve has two general components: reserves for repurchases arising from representation and warranty claims and reserves for repurchases arising from early payment defaults.
 
The reserve level is a function of expected losses based on actual pending claims and repurchase requests, historical experience, loan volume and loan sales distribution channels, the assessment of probable vendor or investor claims and even small changes in assumptions could result in a significantly higher or lower estimate. Our analysis includes an estimate of representation and warranty demands, expected demands due to deteriorating loan performance and probable obligations related to disputes with investors and vendors with respect to contractual obligations pertaining to mortgage origination activity. An increase to this reserve is recorded as a reduction of the “Gain (loss) on sale of loans” in our consolidated statements of operations and the corresponding reserve is recorded in “Other liabilities” in our consolidated balance sheets. At the time we repurchase a loan, the estimated loss on the loan is charged against this reserve and recorded as a reduction of the basis of the loan. The significant increase in the secondary market reserve is due to our expectation of significantly higher volumes of repurchase demands and increased loss severity from declining home prices.
 
SENSITIVITY ANALYSIS
 
Changing the assumptions used to estimate the fair value of AAA-rated and agency interest-only securities, MSRs, principal-only securities, prepayment penalty securities, late fee securities, investment grade securities, non-investment grade securities and residuals (“the retained assets”) could materially impact the amount recorded in our balance sheet and in our gain on sale of loans. Initially, the estimation of the fair value of the retained assets from loan securitizations and sales impacts the financial statements of our mortgage-banking segment. Thereafter,


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adjustments to fair value impact the retained assets and servicing division’s financial statements. Provisions to the secondary market reserves and adjustments to the ALL may impact any of our segments. Refer to “Note 13 — Transfers and Servicing of Financial Assets” in the consolidated financial statements of Indymac for further information on the hypothetical effect on the fair value of our retained assets using various unfavorable variations of the expected levels of certain key assumptions used in valuing these assets at December 31, 2007.
 
REGULATORY UPDATE
 
In December 2007, the OTS endorsed a private-sector initiative to help families avoid foreclosure and stay in their homes. The American Securitization Forum (“ASF”), representing mortgage investors, and the HOPE NOW alliance (“HOPE NOW”), whose members represent more than 80% of the subprime mortgage servicing market, developed the details of the streamlined process for refinancing and modifying subprime adjustable-rate mortgages. The new process is intended as a blueprint for standard industry practice.
 
The OTS endorsed private-sector initiative consists of the Streamlined Foreclosure and Loss Avoidance Framework (the “ASF Framework”), which was issued by the ASF during the same month. The ASF Framework requires a borrower and its U.S. subprime residential mortgage variable loan to meet specific conditions to qualify for a modification under which the qualifying borrower’s loan interest rate would be kept at the existing rate, generally for five years following an upcoming reset period. The ASF Framework is focused on U.S. subprime first-lien adjustable-rate residential mortgages that have an initial fixed interest rate period of 36 months or less, are included in securitized pools, were originated between January 1, 2005 and July 31, 2007, and have an initial interest rate reset date between January 1, 2008 and July 31, 2010. Any loan modifications we make in accordance with the ASF Framework will not have a material impact on our accounting for the mortgage loans.
 
Prior to the aforementioned endorsement in December 2007, the OTS, as well as other federal banking agencies, issued a statement related to loss mitigation strategies for servicers of residential mortgages. This statement, which is broader than the ASF Framework, provides guidance to servicers under the governing securitization documents to take appropriate steps when an increased risk of default is identified, including, proactively identifying borrowers at heightened risk of delinquency or default, such as those with interest rate resets; contacting borrowers to assess their ability to pay; assessing whether there is reasonable basis to conclude that default is “reasonably foreseeable”; and exploring where appropriate, a loss mitigation strategy that avoids foreclosure or other actions that result in a loss of homeownership. Management believes the Company’s loss mitigation activities comply with this OTS issued statement.
 
OTHER CONSIDERATIONS
 
Under OTS regulations, limitations have been imposed on all capital distributions, including cash dividends. IndyMac Bancorp, as the holding company for the Bank, is substantially dependent upon dividends from the Bank for cash used to pay dividends on common stock and other cash outflows. We are required to seek approval from the OTS in order to pay dividends from the Bank to the Parent Company. There is no assurance that the Bank will be able to pay such dividends in the future or that the OTS will continue to grant approvals. While the holding company maintains cash balances at all times to manage its liquidity, a disruption in dividends from the Bank could cause the holding company to reduce or eliminate the dividends paid on common stock.
 
For holders of the Bank’s Series A preferred stock and IndyMac Bancorp’s common stock, dividends we pay will be treated as dividends for U.S. federal income tax purposes only to the extent paid out of our current or accumulated “earnings and profits.” Any dividend that we pay at a time when we do not have any current or accumulated earnings and profits will not be taxable as a dividend for U.S. federal income tax purposes, and instead will be treated first as a return of capital, reducing a holder’s basis in its stock to the extent of such basis, and thereafter as capital gain. Any dividends we pay that are not treated as dividends will not be eligible for the dividends-received deduction or the reduced rates of taxation available for certain holders subject to U.S. federal income tax.


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APPENDIX A:  ADDITIONAL QUANTITATIVE DISCLOSURES
 
We believe the information provided in the body of this Form 10-K provides a good overview of our business and our results for 2007. However, we include the following for a more detailed analysis of our operations:
 
TABLE OF CONTENTS
 
                 
Table
     
Page
 
 
1
    Product Profitability Analysis     87  
 
2
    S&P Lifetime Loss Estimates     96  
 
3
    Production by Product — FICO and CLTV     96  
 
4
    SFR Mortgage Loan Production and Pipeline by Purpose     97  
 
5
    SFR Mortgage Loan Production by Amortization Type     97  
 
6
    SFR Mortgage Loan Production by Geographic Distribution     98  
 
7
    MBR Margin     98  
 
8
    Servicing Fee Income     99  
 
9
    Gain (Loss) on Mortgage-Backed Securities     99  
 
10
    Mortgage-Backed Securities by Credit Rating     100  
 
11
    Other Retained Assets     101  
 
12
    Valuation of MSRs, Interest-Only, Prepayment Penalty and Residual Securities     103  
 
13
    Deposits by Channel     104  
 
14
    Average Balance and Rate of Deposits by Category     104  


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TABLE 1.   PRODUCT PROFITABILITY ANALYSIS
 
As part of our process of measuring results and holding managers responsible for specific targets, we evaluate profitability at the product level in addition to our segment results. We currently have four product groups: standard consumer home loans held for sale, specialty consumer home loans held for sale and/or investment, home loans and related investments, and specialty commercial loans held for sale and/or investment.
 
As conditions in the U.S. mortgage market have deteriorated, we have discontinued certain products and are reporting them in a separate category, “Discontinued Products”. Discontinued products include closed-end second liens (“seconds”), HELOCs, subdivision loans and manufactured housing loans.
 
See the table below for details on the products included within each product group.
 
Standard Consumer Home
Loans Held for Sale
Includes first mortgage products originated for sale through the various Indymac channels (excluding the servicing retention channel and consumer construction division). These products include prime and subprime loans.
 
Prime
 
First mortgage loans for sale that meet the underwriting guidelines of Fannie Mae and Freddie Mac or that have prime credit characteristics but do not meet the GSE underwriting guidelines.
 
Subprime
 
Includes first mortgage loans that are extended to borrowers with impaired credit with one or more of the following characteristics: 1) FICO score of less than 620; 2) late mortgage payment in the last 12 months; or 3) bankruptcy in the last 2 years.
 
Specialty Consumer Home
Loans Held for Sale and/or
Investment
Includes specialty mortgage products originated through the various Indymac channels and adjusted for intercompany activity. These products include reverse mortgages and CTP/Lot.
 
Reverse Mortgages
 
Reverse mortgage loans extended to borrowers age 62 and older secured by equity in a primary residence.
 
CTP/Lot
 
CTP loans made to homeowners for the construction of new custom homes which automatically convert to permanent mortgage loans at the end of construction; and lot loans.
 
Home Loans and Related Investments Includes all investment related activity including home loans held for investment, variable cash flow instruments, mortgage-backed securities and other related investments.
 
Retained Assets and Retention Activities
 
Mortgage banking, trading and hedging activity associated with the purchase, management and sale of mortgage banking assets and variable cash flow instruments retained in connection with the Company’s loan sales. Activity also includes loans acquired through clean-up calls and originated through customer retention programs.


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MBS
 
Trading and investment activity related to the purchase, management and sale of investment grade and non-investment grade mortgage-backed securities.
 
SFR Loans Held for Investment
 
Company-wide loan investment activity related to the purchase, management and sale of single family residential mortgage loans held for investment.
 
Specialty Commercial Loans
Held for Sale and/or

Investment
Includes the consolidated loan activity associated with loans that are made to commercial customers such as commercial builders and mortgage brokers and bankers for the purposes of either building residential homes or financing the purchase of these homes.
 
Single Spec
 
Loans that are made to homebuilders to build individual custom homes for resale to consumers.
 
Warehouse Lending
 
Warehouse lines of credit to mortgage brokers to finance their inventory of loans prior to sale.
 
Commercial Real Estate Lending
 
Permanent loans for multi-family and commercial properties.
 
Overhead Includes all fixed operating costs associated with production divisions and servicing loans that are not allocated to the respective products for which these services are provided. In addition, it includes all corporate fixed costs that do not vary in the short term with changes in business activity. These fixed costs include corporate administration, financial management, enterprise risk management, centralized information technology and other unallocated fixed costs.
 
Discontinued Products HELOCs/Seconds
 
Home equity lines of credit and closed-end second lien mortgages.
 
Subdivision
 
Subdivision lending for commercial acquisition, development and construction loans to commercial builders.
 
Other
 
Dealer originated manufactured housing and home improvement loans.


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The following summarizes the profitability for each of the four product groups and the discontinued products group for the years indicated (dollars in thousands):
 
                                                                         
                Home
                                     
    Standard
    Specialty
    Loans &
    Specialty
                Total
             
    Consumer
    Consumer
    Related
    Commercial
                On-Going
    Discontinued
    Total
 
    Home Loans     Home Loans     Investments     Loans     Treasury     Overhead     Products     Products     Company  
 
Year Ended December 31, 2007
                                                                       
                                                                         
Operating Results
                                                                       
Net interest income
  $ 156,573     $ 82,226     $ 162,621     $ 16,646     $ 2,597     $ 16,462     $ 437,125     $ 129,617     $ 566,742  
Provision for loan losses
          (35,856 )     (145,364 )     (4,699 )                 (185,919 )     (209,629 )     (395,548 )
Gain (loss) on sale of loans
    (233,739 )     177,324       48,899       (5,138 )           (192 )     (12,846 )     (341,514 )     (354,360 )
Service fee income
          38,046       454,695       3             2,263       495,007       24,246       519,253  
Gain (loss) on securities
          (1,629 )     (301,775 )                       (303,404 )     (136,309 )     (439,713 )
Gain on sale and leaseback of building
                                  23,982       23,982             23,982  
Other income
    28,253       22,247       10,771       5,018       1,269       4,894       72,452       10,756       83,208  
                                                                         
Net revenue (expense)
    (48,913 )     282,358       229,847       11,830       3,866       47,409       526,397       (522,833 )     3,564  
Variable expenses
    274,901       116,610       24,236       3,817                   419,564       34,458       454,022  
Severance charges
                                  31,850       31,850             31,850  
Deferral of expenses under SFAS 91
    (189,542 )     (35,585 )     (10,440 )     (1,127 )                 (236,694 )     (22,461 )     (259,155 )
Fixed expenses
    243,211       82,369       90,677       13,411       12,190       277,843       719,701       28,993       748,694  
                                                                         
Pre-tax earnings (loss)
    (377,483 )     118,964       125,374       (4,271 )     (8,324 )     (262,284 )     (408,024 )     (563,823 )     (971,847 )
                                                                         
Minority interests
    456       412       1,522       64       7,630       12,475       22,559       462       23,021  
                                                                         
Net earnings (loss)
  $ (230,343 )   $ 71,423     $ 74,832     $ (2,666 )   $ (12,699 )   $ (171,525 )   $ (270,978 )   $ (343,830 )   $ (614,808 )
                                                                         
Performance Data
                                                                       
Average interest-earning assets
  $ 10,241,209     $ 3,548,742     $ 13,007,665     $ 478,270     $     $ 537,109     $ 27,812,995     $ 3,419,191     $ 31,232,186  
Allocated capital
  $ 474,759     $ 172,351     $ 801,757     $ 38,843     $     $ 160,305     $ 1,648,015     $ 328,917     $ 1,976,932  
Loan production
    59,529,001       9,617,560       4,156,353       543,931                   73,846,845       4,469,539       78,316,384  
Loans sold
    53,730,095       7,417,072       7,807,414                         68,954,581       2,209,143       71,163,724  
MBR margin
    (0.09 )%     3.01 %     0.63 %     N/A       N/A       N/A       0.24 %     (14.29 )%     (0.22 )%
ROE
    (49 )%     41 %     9 %     (7 )%     N/A       N/A       (16 )%     (105 )%     (31 )%
Net interest margin
    1.53 %     2.32 %     1.25 %     3.48 %     N/A       N/A       1.57 %     3.79 %     1.81 %
Efficiency ratio
    (135 )%     51 %     28 %     97 %     N/A       N/A       131 %     (13 )%     244 %
                                                                         
Year Ended December 31, 2006
                                                                       
                                                                         
Operating Results
                                                                       
Net interest income
  $ 126,582     $ 58,214     $ 168,025     $ 16,795     $ (3,343 )   $ 6,992     $ 373,265     $ 153,456     $ 526,721  
Provision for loan losses
          (2,906 )     (9,225 )     (597 )                 (12,728 )     (7,265 )     (19,993 )
Gain (loss) on sale of loans
    432,508       201,605       35,058                         669,171       (1,117 )     668,054  
Service fee income
          21,141       72,227                   1,951       95,319       5,998       101,317  
Gain (loss) on securities
          659       37,331                         37,990       (17,508 )     20,482  
Other income
          20,512       6,920       5,777       677       3,917       37,803       12,319       50,122  
                                                                         
Net revenue (expense)
    559,090       299,225       310,336       21,975       (2,666 )     12,860       1,200,820       145,883       1,346,703  
Variable expenses
    233,344       116,702       11,994       2,694                   364,734       61,428       426,162  
Deferral of expenses under SFAS 91
    (178,637 )     (40,760 )     (5,772 )     (308 )                 (225,477 )     (40,769 )     (266,246 )
Fixed expenses
    186,182       83,002       52,818       6,817       8,529       269,174       606,522       24,769       631,291  
                                                                         
Pre-tax earnings (loss)
    318,201       140,281       251,296       12,772       (11,195 )     (256,314 )     455,041       100,455       555,496  
                                                                         
Net earnings (loss)
  $ 193,785     $ 84,779     $ 153,039     $ 7,779     $ (6,818 )   $ (150,812 )   $ 281,752     $ 61,177     $ 342,929  
                                                                         
Performance Data
                                                                       
Average interest-earning assets
  $ 8,536,707     $ 2,866,578     $ 9,915,750     $ 363,337     $     $ 562,241     $ 22,244,613     $ 3,783,663     $ 26,028,276  
Allocated capital
  $ 398,215     $ 134,942     $ 625,456     $ 29,694     $     $ 266,316     $ 1,454,623     $ 341,637     $ 1,796,260  
Loan production
    70,043,484       10,284,979       2,232,454       190,908                   82,751,825       8,945,999       91,697,824  
Loans sold
    63,635,182       6,994,666       2,226,201                         72,856,049       6,192,913       79,048,962  
MBR margin
    0.88 %     3.56 %     1.57 %     N/A       N/A       N/A       1.11 %     0.58 %     1.06 %
ROE
    49 %     63 %     24 %     26 %     N/A       N/A       19 %     18 %     19 %
Net interest margin
    1.48 %     2.03 %     1.69 %     4.62 %     N/A       N/A       1.68 %     4.06 %     2.02 %
Efficiency ratio
    43 %     53 %     18 %     41 %     N/A       N/A       61 %     30 %     58 %


89


Table of Contents

The following provides details on the profitability for the standard consumer home loans held for sale for the years indicated (dollars in thousands):
 
                         
    Standard Consumer Home Loans  
    Prime     Subprime     Total  
 
Year Ended December 31, 2007
                       
Operating Results
                       
Net interest income
  $ 149,249     $ 7,324     $ 156,573  
Provision for loan losses
                 
Gain (loss) on sale of loans
    (206,277 )     (27,462 )     (233,739 )
Service fee income
                 
Gain (loss) on securities
                 
Other income
    27,367       886       28,253  
                         
Net revenues (expense)
    (29,661 )     (19,252 )     (48,913 )
Variable expenses
    250,261       24,640       274,901  
Deferral of expenses under SFAS 91
    (172,224 )     (17,318 )     (189,542 )
Fixed expenses
    224,547       18,664       243,211  
                         
Pre-tax earnings (loss)
    (332,245 )     (45,238 )     (377,483 )
                         
Minority interests
    449       7       456  
                         
Net earnings (loss)
  $ (202,786 )   $ (27,557 )   $ (230,343 )
                         
Performance Data
                       
Average interest-earning assets
  $ 9,996,322     $ 244,887     $ 10,241,209  
Allocated capital
  $ 460,005     $ 14,754     $ 474,759  
Loan production
    56,986,937       2,542,064       59,529,001  
Loans sold
    51,466,679       2,263,416       53,730,095  
MBR margin
    (0.06 )%     (0.85 )%     (0.09 )%
ROE
    (44 )%     (187 )%     (49 )%
Net interest margin
    1.49 %     2.99 %     1.53 %
Efficiency ratio
    N/M       (135 )%     N/M  
                         
Year Ended December 31, 2006
                       
Operating Results
                       
Net interest income
  $ 110,903     $ 15,679     $ 126,582  
Provision for loan losses
                 
Gain (loss) on sale of loans
    409,503       23,005       432,508  
Service fee income
                 
Gain (loss) on securities
                 
Other income
                 
                         
Net revenues (expense)
    520,406       38,684       559,090  
Variable expenses
    204,391       28,953       233,344  
Deferral of expenses under SFAS 91
    (156,352 )     (22,285 )     (178,637 )
Fixed expenses
    168,511       17,671       186,182  
                         
Pre-tax earnings (loss)
    303,856       14,345       318,201  
                         
Net earnings (loss)
  $ 185,049     $ 8,736     $ 193,785  
                         
Performance Data
                       
Average interest-earning assets
  $ 7,956,667     $ 580,040     $ 8,536,707  
Allocated capital
  $ 362,396     $ 35,819     $ 398,215  
Loan production
    67,458,207       2,585,277       70,043,484  
Loans sold
    61,013,270       2,621,912       63,635,182  
MBR margin
    0.85 %     1.48 %     0.88 %
ROE
    51 %     24 %     49 %
Net interest margin
    1.39 %     2.70 %     1.48 %
Efficiency ratio
    42 %     63 %     43 %


90


Table of Contents

The following provides details on the profitability for the specialty consumer home loans held for sale and/or investment for the years indicated (dollars in thousands):
 
                         
    Specialty Consumer Home Loans
    Reverse
       
    Mortgages   CTP/Lot   Total
 
Year Ended December 31, 2007
                       
Operating Results
                       
Net interest income
  $ 19,788     $ 62,438     $ 82,226  
Provision for loan losses
          (35,856 )     (35,856 )
Gain (loss) on sale of loans
    139,417       37,907       177,324  
Service fee income
    38,046             38,046  
Gain (loss) on securities
          (1,629 )     (1,629 )
Other income
    354       21,893       22,247  
                         
Net revenues (expense)
    197,605       84,753       282,358  
Variable expenses
    83,354       33,256       116,610  
Deferral of expenses under SFAS 91
    (27,631 )     (7,954 )     (35,585 )
Fixed expenses
    53,471       28,898       82,369  
                         
Pre-tax earnings (loss)
    88,411       30,553       118,964  
                         
Minority interests
    232       180       412  
                         
Net earnings (loss)
  $ 52,997     $ 18,426     $ 71,423  
                         
Performance Data
                       
Average interest-earning assets
  $ 967,173     $ 2,581,569     $ 3,548,742  
Allocated capital
  $ 55,627     $ 116,724     $ 172,351  
Loan production
    4,722,885       4,894,675       9,617,560  
Loans sold
    4,789,805       2,627,267       7,417,072  
MBR margin
    3.32 %     1.44 %     3.01 %
ROE
    95 %     16 %     41 %
Net interest margin
    2.05 %     2.42 %     2.32 %
Efficiency ratio
    55 %     45 %     51 %
                         
Year Ended December 31, 2006
                       
Operating Results
                       
Net interest income
  $ 9,918     $ 48,296     $ 58,214  
Provision for loan losses
          (2,906 )     (2,906 )
Gain (loss) on sale of loans
    160,844       40,761       201,605  
Service fee income
    21,141             21,141  
Gain (loss) on securities
          659       659  
Other income
    1,152       19,360       20,512  
                         
Net revenues (expense)
    193,055       106,170       299,225  
Variable expenses
    79,858       36,844       116,702  
Deferral of expenses under SFAS 91
    (32,256 )     (8,504 )     (40,760 )
Fixed expenses
    55,388       27,614       83,002  
                         
Pre-tax earnings (loss)
    90,065       50,216       140,281  
                         
Net earnings (loss)
  $ 54,198     $ 30,581     $ 84,779  
                         
Performance Data
Average interest-earning assets
  $ 617,480     $ 2,249,098     $ 2,866,578  
Allocated capital
  $ 31,712     $ 103,230     $ 134,942  
Loan production
    5,023,533       5,261,446       10,284,979  
Loans sold
    4,498,352       2,496,314       6,994,666  
MBR margin
    3.80 %     1.63 %     3.56 %
ROE
    171 %     30 %     63 %
Net interest margin
    1.61 %     2.15 %     2.03 %
Efficiency ratio
    53 %     51 %     53 %


91


Table of Contents

The following provides details on the profitability for the home loans and related investments and the loan servicing operations for the years indicated (dollars in thousands):
 
                                 
    Home Loans and Related Investments  
    Retained Servicing
          SFR Loans
       
    and Retention
          Held for
       
    Activities     MBS     Investment     Total  
 
Year Ended December 31, 2007
                               
Operating Results
                               
Net interest income
  $ 4,197     $ 74,652     $ 83,772     $ 162,621  
Provision for loan losses
                (145,364 )     (145,364 )
Gain (loss) on sale of loans
    56,124             (7,225 )     48,899  
Service fee income
    454,695                   454,695  
Gain (loss) on securities
    (37,968 )     (263,807 )           (301,775 )
Other income
    8,096       610       2,065       10,771  
                                 
Net revenues (expense)
    485,144       (188,545 )     (66,752 )     229,847  
Variable expenses
    24,236                   24,236  
Deferral of expenses under SFAS 91
    (10,440 )                 (10,440 )
Fixed expenses
    63,792       3,794       23,091       90,677  
                                 
Pre-tax earnings (loss)
    407,556       (192,339 )     (89,843 )     125,374  
                                 
Minority interests
    614       416       492       1,522  
                                 
Net earnings (loss)
  $ 247,588     $ (117,550 )   $ (55,206 )   $ 74,832  
                                 
Performance Data
                               
Average interest-earning assets
  $ 1,172,090     $ 5,074,815     $ 6,760,760     $ 13,007,665  
Allocated capital
  $ 353,415     $ 209,563     $ 238,779     $ 801,757  
Loan production
    4,156,353                   4,156,353  
Loans sold
    4,071,678             3,735,736       7,807,414  
MBR margin
    1.38 %     N/A       N/A       0.63 %
ROE
    70 %     (56 )%     (23 )%     9 %
Net interest margin
    0.36 %     1.47 %     1.24 %     1.25 %
Efficiency ratio
    16 %     (2 )%     29 %     28 %
                                 
Year Ended December 31, 2006
                               
Operating Results
                               
Net interest income
  $ 12,752     $ 72,217     $ 83,056     $ 168,025  
Provision for loan losses
                (9,225 )     (9,225 )
Gain (loss) on sale of loans
    31,477       (122 )     3,703       35,058  
Service fee income
    72,227                   72,227  
Gain (loss) on securities
    34,556       2,391       384       37,331  
Other income
    5,286       (3 )     1,637       6,920  
                                 
Net revenues (expense)
    156,298       74,483       79,555       310,336  
Variable expenses
    11,994                   11,994  
Deferral of expenses under SFAS 91
    (5,772 )                 (5,772 )
Fixed expenses
    44,291       3,549       4,978       52,818  
                                 
Pre-tax earnings (loss)
    105,785       70,934       74,577       251,296  
                                 
Net earnings (loss)
  $ 64,423     $ 43,199     $ 45,417     $ 153,039  
                                 
Performance Data
                               
Average interest-earning assets
  $ 520,965     $ 3,539,470     $ 5,855,315     $ 9,915,750  
Allocated capital
  $ 223,023     $ 175,352     $ 227,081     $ 625,456  
Loan production
    2,232,454                   2,232,454  
Loans sold
    2,055,905             170,296       2,226,201  
MBR margin
    1.53 %     N/A       N/A       1.57 %
ROE
    29 %     25 %     20 %     24 %
Net interest margin
    2.45 %     2.04 %     1.42 %     1.69 %
Efficiency ratio
    32 %     5 %     6 %     18 %


92


Table of Contents

The following provides details on the profitability for the specialty commercial loans held for sale and/or investment for the years indicated (dollars in thousands):
 
                                 
    Specialty Commercial Loans  
                Commercial
       
          Warehouse
    Real Estate
       
    Single Spec     Lending     Lending     Total  
 
Year Ended December 31, 2007
                               
Operating Results
                               
Net interest income
  $ 10,581     $ 5,193     $ 872     $ 16,646  
Provision for loan losses
    (4,400 )     (299 )           (4,699 )
Gain (loss) on sale of loans
                (5,138 )     (5,138 )
Service fee income
                3       3  
Gain (loss) on securities
                       
Other income
    2,767       2,014       237       5,018  
                                 
Net revenues (expense)
    8,948       6,908       (4,026 )     11,830  
Variable expenses
    2,328             1,489       3,817  
Deferral of expenses under SFAS 91
    (297 )           (830 )     (1,127 )
Fixed expenses
    2,065       3,698       7,648       13,411  
                                 
Pre-tax earnings (loss)
    4,852       3,210       (12,333 )     (4,271 )
                                 
Minority interests
    28       7       29       64  
                                 
Net earnings (loss)
  $ 2,927     $ 1,947     $ (7,540 )   $ (2,666 )
                                 
Performance Data
                               
Average interest-earning assets
  $ 212,144     $ 194,286     $ 71,840     $ 478,270  
Allocated capital
  $ 17,625     $ 15,440     $ 5,778     $ 38,843  
Loan production
    183,284             360,647       543,931  
Loans sold
                       
ROE
    17 %     13 %     (130 )%     (7 )%
Net interest margin
    4.99 %     2.67 %     1.21 %     3.48 %
Efficiency ratio
    31 %     51 %     (206 )%     97 %
                                 
Year Ended December 31, 2006
                               
Operating Results
                               
Net interest income
  $ 13,306     $ 3,489     $     $ 16,795  
Provision for loan losses
    (416 )     (181 )           (597 )
Gain (loss) on sale of loans
                       
Service fee income
                       
Gain (loss) on securities
                       
Other income
    4,052       1,725             5,777  
                                 
Net revenues (expense)
    16,942       5,033             21,975  
Variable expenses
    2,694                   2,694  
Deferral of expenses under SFAS 91
    (308 )                 (308 )
Fixed expenses
    1,921       4,120       776       6,817  
                                 
Pre-tax earnings (loss)
    12,635       913       (776 )     12,772  
                                 
Net earnings (loss)
  $ 7,694     $ 557     $ (472 )   $ 7,779  
                                 
Performance Data
                               
Average interest-earning assets
  $ 244,294     $ 119,043     $     $ 363,337  
Allocated capital
  $ 19,312     $ 10,382     $     $ 29,694  
Loan production
    190,908                   190,908  
Loans sold
                       
ROE
    40 %     N/A       N/A       26 %
Net interest margin
    5.45 %     N/A       N/A       4.62 %
Efficiency ratio
    25 %     N/A       N/A       41 %


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The following provides details on the overhead costs for the years indicated (dollars in thousands):
 
                                         
          Mortgage
                   
    Servicing     Banking     Deposit     Corporate(1)     Total Overhead  
 
Year Ended December 31, 2007
                                       
Operating Results
                                       
Net interest income
  $ 20     $ 833     $ 25,349     $ (9,740 )   $ 16,462  
Provision for loan losses
                             
Gain (loss) on sale of loans
    (189 )     (3 )                 (192 )
Service fee income
                      2,263       2,263  
Gain (loss) on securities
                             
Gain on sale and leaseback of building
                      23,982       23,982  
Other income
    2,742       (1,857 )     4,431       (422 )     4,894  
                                         
Net revenues (expense)
    2,573       (1,027 )     29,780       16,083       47,409  
Variable expenses
                             
Severance charges
                      31,850       31,850  
Deferral of expenses under SFAS 91
                             
Fixed expenses
    25,643       48,355       53,164       150,681       277,843  
                                         
Pre-tax earnings (loss)
    (23,070 )     (49,382 )     (23,384 )     (166,448 )     (262,284 )
                                         
Minority interests
          28       3       12,444       12,475  
                                         
Net earnings (loss)
  $ (14,050 )   $ (30,101 )   $ (14,244 )   $ (113,130 )   $ (171,525 )
                                         
Performance Data
                                       
Average interest-earning assets
  $     $ 2,427     $ 176     $ 534,506     $ 537,109  
Allocated capital
  $ (155 )   $ 14,362     $ 4,325     $ 141,773     $ 160,305  
Loan production
                             
Loans sold
                             
ROE
    N/A       N/A       N/A       N/A       N/A  
Net interest margin
    N/A       N/A       N/A       N/A       N/A  
Efficiency ratio
    N/A       N/A       N/A       N/A       N/A  
                                         
Year Ended December 31, 2006
                                       
Operating Results
                                       
Net interest income
  $ (247 )   $ 809     $ 14,364     $ (7,934 )   $ 6,992  
Provision for loan losses
                             
Gain (loss) on sale of loans
                             
Service fee income
                      1,951       1,951  
Gain (loss) on securities
                             
Other income
    3,003       292       3,476       (2,854 )     3,917  
                                         
Net revenues (expense)
    2,756       1,101       17,840       (8,837 )     12,860  
Variable expenses
                             
Deferral of expenses under SFAS 91
                             
Fixed expenses
    19,376       40,621       41,128       168,049       269,174  
                                         
Pre-tax earnings (loss)
    (16,620 )     (39,520 )     (23,288 )     (176,886 )     (256,314 )
                                         
Net earnings (loss)
  $ (10,122 )   $ (24,068 )   $ (14,182 )   $ (102,440 )   $ (150,812 )
                                         
Performance Data
                                       
Average interest-earning assets
  $ 2     $ 2,470     $ 181     $ 559,588     $ 562,241  
Allocated capital
  $ 205     $ 12,643     $ 2,108     $ 251,360     $ 266,316  
Loan production
          N/A       N/A       N/A        
Loans sold
          N/A       N/A       N/A        
ROE
    N/A       N/A       N/A       N/A       N/A  
Net interest margin
    N/A       N/A       N/A       N/A       N/A  
Efficiency ratio
    N/A       N/A       N/A       N/A       N/A  
 
 
(1) Corporate overhead under the product profitability analysis is different from the corporate overhead under the business segment results as certain elimination items are included here.


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The following provides details on the discontinued products for the years indicated (dollars in thousands):
 
                                 
    Discontinued Products  
    HELOCs/
                   
    Seconds     Subdivision     Other     Total  
 
Year Ended December 31, 2007
                               
Operating Results
                               
Net interest income
  $ 81,218     $ 46,602     $ 1,797     $ 129,617  
Provision for loan losses
    (29,960 )     (178,144 )     (1,525 )     (209,629 )
Gain (loss) on sale of loans
    (341,514 )                 (341,514 )
Service fee income
    24,246                   24,246  
Gain (loss) on securities
    (136,309 )                 (136,309 )
Other income
    11,333       (577 )           10,756  
                                 
Net revenues (expense)
    (390,986 )     (132,119 )     272       (522,833 )
Variable expenses
    25,624       8,834             34,458  
Deferral of expenses under SFAS 91
    (16,511 )     (5,950 )           (22,461 )
Fixed expenses
    14,043       14,705       245       28,993  
                                 
Pre-tax earnings (loss)
    (414,142 )     (149,708 )     27       (563,823 )
                                 
Minority interests
    380       78       4       462  
                                 
Net earnings (loss)
  $ (252,593 )   $ (91,250 )   $ 13     $ (343,830 )
                                 
Performance Data
                               
Average interest-earning assets
  $ 2,164,734     $ 1,222,646     $ 31,811     $ 3,419,191  
Allocated capital
  $ 234,295     $ 91,802     $ 2,820     $ 328,917  
Loan production
    3,493,521       976,018             4,469,539  
Loans sold
    2,209,143                   2,209,143  
MBR margin
    (14.29 )%     N/A       N/A       (14.29 )%
ROE
    (108 )%     (99 )%     N/A       (105 )%
Net interest margin
    3.75 %     3.81 %     5.65 %     3.79 %
Efficiency ratio
    (6 )%     38 %     14 %     (13 )%
                                 
Year Ended December 31, 2006
                               
Operating Results
                               
Net interest income
  $ 90,832     $ 60,422     $ 2,202     $ 153,456  
Provision for loan losses
    (1,800 )     (3,800 )     (1,665 )     (7,265 )
Gain (loss) on sale of loans
    (1,106 )           (11 )     (1,117 )
Service fee income
    5,998                   5,998  
Gain (loss) on securities
    (17,508 )                 (17,508 )
Other income
    10,452       1,867             12,319  
                                 
Net revenues (expense)
    86,868       58,489       526       145,883  
Variable expenses
    52,746       8,682             61,428  
Deferral of expenses under SFAS 91
    (33,776 )     (6,993 )           (40,769 )
Fixed expenses
    11,628       12,834       307       24,769  
                                 
Pre-tax earnings
    56,270       43,966       219       100,455  
                                 
Net earnings
  $ 34,268     $ 26,775     $ 134     $ 61,117  
                                 
Performance Data
                               
Average interest-earning assets
  $ 2,666,823     $ 1,076,213     $ 40,627     $ 3,783,663  
Allocated capital
  $ 233,930     $ 104,123     $ 3,584     $ 341,637  
Loan production
    7,199,309       1,746,690             8,945,999  
Loans sold
    6,192,913                   6,192,913  
MBR margin
    0.58 %     N/A       N/A       0.58 %
ROE
    15 %     26 %     4 %     18 %
Net interest margin
    3.41 %     5.61 %     5.42 %     4.06 %
Efficiency ratio
    35 %     23 %     14 %     30 %


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TABLE 2.   S&P LIFETIME LOSS ESTIMATES
 
One method we use to evaluate the credit quality of our production is the S&P Levels model. We believe this model provides another objective, third-party method to evaluate our production. The S&P Levels model is the oldest licensed mortgage loss model in the industry, developed and tested over various economic cycles, and one of only two models accepted by the industry for evaluating securitizations. The loss estimates are shown to describe the relative level of credit risk in our loan production at the time of origination. Because we routinely sell the vast majority of loans produced, these estimates do not reflect the amount of credit risk retained by us. In addition, recent revisions to the model by S&P have resulted in significantly higher losses being estimated than prior versions of the model.
 
The following summarizes the estimated lifetime losses for mortgage production using the S&P Levels model for the years indicated (dollars in millions):
 
                 
    Year Ended December 31  
    2007     2006  
 
Total S&P average lifetime loss estimates(1)
    1.14 %     1.90 %
Total S&P evaluated production(2)
  $ 65,534     $ 74,077  
 
 
(1) All loss estimates reported here have been restated to use S&P’s new 6.1 model which was released in November 2007.
 
(2) While our production is evaluated using the S&P Levels model, the data are not audited or endorsed by S&P. S&P evaluated production excludes second liens, HELOC, reverse mortgages, and construction loans.
 
Total average lifetime loss rate for the year ended December 31, 2007 decreased 76 basis points to 1.14% from 1.90% for the year ended December 31, 2006. The year-over-year decrease was due to us substantially eliminating subprime loans, low documentation Alt-A loans and 80/20 piggyback loans from our product offerings. For the quarter ended December 2007, the S&P lifetime loss estimates on new production was 45 bps.
 
TABLE 3.   PRODUCTION BY PRODUCT — FICO AND CLTV
 
The following shows the average FICO and CLTV by portfolio for loans originated during the years indicated (dollars in millions):
 
                                                 
    Year Ended December 31
    2007   2006
    Production     FICO     CLTV   Production     FICO     CLTV
 
Total production
  $ 78,316       N/A       N/A     $ 91,698       N/A       N/A  
Less:
                                               
HELOCs(1)/Seconds
    3,496       711       85%       7,199       712       88%  
Reverse mortgages
    4,723       N/A       57%       5,024       N/A       54%  
Consumer construction(1)
    3,182       726       75%       3,651       721       76%  
Government — FHA/VA
    44       N/A       N/A             N/A       N/A  
Commercial real estate
    361       730       68%             N/A        
Builder construction commitments(1)
    976       N/A       73%       1,747       N/A       74%  
                                         
Total S&P evaluated production
  $ 65,534       703       78%     $ 74,077       701       80%  
                                         
 
 
(1) Amounts represent total commitments.


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TABLE 4.   SFR MORTGAGE PRODUCTION AND PIPELINE BY PURPOSE
 
The following presents SFR mortgage loan production and pipeline by purpose as of and for the years indicated (dollars in millions):
 
                         
    As of and For the Year Ended December 31  
    2007     2006     % Change  
 
Production and Pipeline by Purpose:
                       
SFR mortgage loan production:
                       
Purchase transactions
  $ 26,197     $ 35,189       (26 )%
Cash-out refinance transactions
    34,740       41,764       (17 )%
Rate/term refinance transactions
    16,042       12,998       23 %
                         
Total SFR mortgage loan production
  $ 76,979     $ 89,951       (14 )%
                         
% purchase and cash-out refinance transactions
    79 %     86 %     (8 )%
% of loan production GSE eligible
    53 %     40 %     33 %
Mortgage industry market share
    3.30 %     3.30 %      
                         
SFR mortgage loan pipeline at period end(1):
                       
Purchase transactions
  $ 2,563     $ 3,914       (35 )%
Cash-out refinance transactions
    2,891       4,193       (31 )%
Rate/term refinance transactions
    2,052       1,792       15 %
                         
Total specific rate locks
    7,506       9,899       (24 )%
Non-specific rate locks on bulk purchases
          1,922       N/A  
                         
Total SFR mortgage loan pipeline
  $ 7,506     $ 11,821       (37 )%
                         
 
 
(1) Total pipeline of loans in process includes rate lock commitments we have provided on loans that are specifically identified or non-specific bulk packages, and loan applications we have received for which the borrower has not yet locked in the interest rate commitment. Non-specific bulk packages represent pools of loans we have committed to purchase, where the pool characteristics are specified but the actual loans are not.
 
TABLE 5.   SFR MORTGAGE LOAN PRODUCTION BY AMORTIZATION TYPE
 
The following presents SFR mortgage loan production by amortization type for the years indicated:
 
                 
    Year Ended December 31  
    2007     2006  
 
SFR Mortgage Production by Amortization Type:
               
Fixed-rate mortgages
    28 %     21 %
Intermediate term fixed-rate loans
    7 %     7 %
Interest-only loans
    44 %     37 %
Pay option ARMs
    9 %     23 %
Other ARMs
    12 %     12 %
                 
      100 %     100 %
                 


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TABLE 6.   SFR MORTGAGE LOAN PRODUCTION BY GEOGRAPHIC DISTRIBUTION
 
The following presents SFR mortgage loan production by geographic distribution for the years indicated:
 
                 
    Year Ended December 31  
    2007     2006  
 
Geographic distribution:
               
California
    43 %     45 %
Florida
    8 %     8 %
New York
    7 %     6 %
New Jersey
    4 %     4 %
Arizona
    3 %     3 %
Other
    35 %     34 %
                 
Total
    100 %     100 %
                 
 
TABLE 7.   MBR MARGIN
 
The following shows a reconciliation of gross MBR margin to net MBR margin for the years indicated (in basis points unless otherwise noted):
 
                         
    Year Ended December 31  
    2007     2006     2005  
 
Loans sold (in millions)
  $ 71,164     $ 79,049     $ 52,297  
Gross MBR
    100       150       159  
Pipeline hedging
    (2 )     (9 )     11  
MBR after hedging(a)
    99       141       170  
Net HFS credit losses
    (66 )     (8 )     (3 )
Secondary market reserve accrual
    (33 )     (5 )     (5 )
Total production credit costs(b)
    (98 )     (13 )     (8 )
Production credit costs/MBR after hedging(b/a)
    99 %     9 %     5 %
Net MBR after production credit costs/MBR after hedging
          128       162  
FAS 91 deferred cost
    (23 )     (22 )     (25 )
Net MBR reported
    (22 )     106       137  


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TABLE 8.   SERVICING FEE INCOME
 
The following presents the components of service fee income for the Company for the years indicated (dollars in thousands):
 
                                                 
    Year Ended December 31  
          BPS
          BPS
          BPS
 
    2007     UPB     2006     UPB     2005     UPB  
 
Service fee income:
                                               
Gross service fee income
  $ 705,637       43     $ 500,904       45     $ 282,420       44  
Change in MSR value due to portfolio run-off
    (408,107 )     (25 )     (374,955 )     (34 )     (227,085 )     (35 )
                                                 
Service fee income, net of change in value due to portfolio run-off
    297,530       18       125,949       11       55,335       9  
Change in MSR value due to application of external benchmarking policies
    3,920             (16,459 )     (1 )            
MSR valuation adjustment due to market changes
    156,327       10       24,180       2       (13,460 )     (2 )
Gain (loss) on financial instruments used to hedge MSRs
    61,476       4       (32,353 )     (3 )     2,360        
                                                 
Total
  $ 519,253       32     $ 101,317       9     $ 44,235       7  
                                                 
 
As a result of the growth in our servicing portfolio and slower run-off of the portfolio, servicing income before hedging activities increased during the year ended December 31, 2007, compared to the prior year. In addition, the financial instruments used to hedge MSRs also experienced a gain of $61.5 million this year, compared to a loss of $32.4 million in 2006.
 
TABLE 9.   GAIN (LOSS) ON MORTGAGE-BACKED SECURITIES
 
The following presents the components of the Company’s gain (loss) on MBS for the years indicated (dollars in thousands):
 
                         
    Year Ended December 31  
    2007     2006     2005  
 
Net gain (loss) on MBS:
                       
Realized loss on available for sale securities
  $ (486 )   $ 3,715     $ 6,054  
Impairments on available for sale securities
    (40,036 )     (10,238 )     (607 )
Unrealized gain (loss) on prepayment penalty securities
    (44,215 )     23,625       21,694  
Unrealized gain (loss) on late fee securities
    183              
Unrealized gain (loss) on AAA-rated and agency interest-only securities
    (1,204 )     3,136       (13,864 )
Unrealized gain (loss) on non-investment grade residual securities
    (146,378 )     (1,444 )     (3,106 )
Net gain (loss) on trading securities and other instruments(1)
    (207,577 )     1,688       7,695  
                         
Total gain (loss) on MBS, net
  $ (439,713 )   $ 20,482     $ 17,866  
                         
 
 
(1) The amount for the year ended December 31, 2007 includes $126.2 million of credit related losses on non-investment grade securities.


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TABLE 10.   MORTGAGE-BACKED SECURITIES BY CREDIT RATING
 
The following presents fair values of MBS by credit ratings as of the dates indicated (dollars in thousands):
 
                                         
    December 31, 2007        
    Current
    Net Premium
                December 31,
 
    Face
    (Discount) to
    Amortized
          2006
 
    Value     Face Value     Cost     Fair Value     Fair Value  
 
AAA-rated mortgage-backed securities:
                                       
AAA-rated non-agency securities
  $ 6,127,260     $ 23,108     $ 6,150,368     $ 6,053,677     $ 4,648,446  
AAA-rated agency securities
    46,465       (240 )     46,225       45,296       65,175  
AAA-rated and agency interest-only securities
                      59,844       73,570  
AAA-rated principal-only securities
                      88,024       38,478  
                                         
Total AAA-rated mortgage-backed securities
  $ 6,173,725     $ 22,868     $ 6,196,593     $ 6,246,841     $ 4,825,669  
                                         
Prepayment penalty and late fee securities
                          $ 82,027     $ 97,576  
                                         
Other investment grade mortgage-backed securities:
                                       
AA+
  $ 23,230     $ (3,076 )   $ 20,154     $ 18,569     $ 7,513  
AA
    508,435       (28,019 )     480,416       424,701       86,311  
AA−
    18,944       (1,061 )     17,883       14,864       14,138  
A+
    15,606       (3,702 )     11,904       11,904        
A
    199,054       (20,348 )     178,706       146,737       2,160  
A−
    16,490       (2,865 )     13,625       13,625        
BBB+
    5,423       (67 )     5,356       3,215        
BBB
    66,250       (24,753 )     41,497       41,828       20,734  
BBB−
    79,109       (26,518 )     52,591       52,046       58,397  
                                         
Total other investment grade mortgage-backed securities
  $ 932,541     $ (110,409 )   $ 822,132     $ 727,489     $ 189,253  
                                         
Non-investment grade mortgage-backed securities:
                                       
BB+
  $ 2,509     $ (2,494 )   $ 15     $ 15     $ 7,299  
BB
    132,546       (53,589 )     78,957       79,859       49,856  
BB−
    67,312       (37,941 )     29,371       29,371       21,170  
B
    69,007       (46,165 )     22,842       23,250       1,442  
B−
    44,405       (35,895 )     8,510       8,510        
CCC+
                             
CCC
    29,887       (25,489 )     4,398       4,416        
CC
    20,727       (20,191 )     536       536        
C
    24,353       (20,726 )     3,627       3,627        
D
    1,226       (1,226 )                  
Other
    67,886       (61,807 )     6,079       6,164       407  
                                         
Total other non-investment grade mortgage-backed securities
  $ 459,858     $ (305,523 )   $ 154,335     $ 155,748     $ 80,174  
                                         
Non-investment grade residual securities
                          $ 116,414     $ 250,573  
                                         
Total mortgage-backed securities
                          $ 7,328,519     $ 5,443,245  
                                         
 
At December 31, 2007, other investment grade and non-investment grade MBS totaled $883.2 million, of which 94% were collateralized by prime loans and 6% were collateralized by subprime loans.


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TABLE 11.   OTHER RETAINED ASSETS
 
The carrying value of AAA-rated and agency interest-only, principal-only, prepayment penalty, late fee, non-investment grade, and residual securities is evaluated by discounting estimated net future cash flows. For these securities, estimated net future cash flows are primarily based on assumptions related to prepayment speeds, in addition to expected credit loss assumptions on the residual securities. The models used for estimation are periodically tested against historical prepayment speeds and our valuations are benchmarked to external sources, where available. We also may retain certain other investment grade securities from our securitizations and to a lesser extent purchase from third parties to serve as hedges for our AAA-rated and agency interest-only securities.


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The following presents a summary of the activity of the retained assets for the years indicated (dollars in thousands):
 
                 
    Year Ended December 31  
    2007     2006  
 
AAA-rated and agency interest-only and other investment grade securities:
               
Beginning balance
  $ 262,823     $ 170,851  
Retained investments from securitizations
    525,658       73,277  
Purchases
    277,060       72,366  
Transfer from MSRs
    56,040        
Transfer to non-investment grade securities
    (61,360 )      
Impairment
    (24,380 )     (183 )
Sales
    (71,225 )     (32,735 )
Clean-up calls exercised
          (107 )
Cash received, net of accretion
    (35,949 )     (23,607 )
Valuation gains before hedges
    (141,334 )     2,961  
                 
Ending balance
  $ 787,333     $ 262,823  
                 
Principal-only securities:
               
Beginning balance
  $ 38,478     $ 9,483  
Retained investments from securitizations
    8,157       13,862  
Purchases
    44,472       121,281  
Sales
          (100,761 )
Cash received, net of accretion
    (1,231 )     (4,576 )
Valuation gains (losses) before hedges
    (1,852 )     (811 )
                 
Ending balance
  $ 88,024     $ 38,478  
                 
Prepayment penalty and late fee securities:
               
Beginning balance
  $ 97,576     $ 75,741  
Retained investments from securitizations
    47,555       43,094  
Transfer from MSRs/residual securities
    3,359       4,523  
Sales
          (2,078 )
Cash received, net of accretion
    (22,431 )     (47,329 )
Valuation gains (losses) before hedges
    (44,032 )     23,625  
                 
Ending balance
  $ 82,027     $ 97,576  
                 
Non-investment grade securities:
               
Beginning balance
  $ 80,173     $ 57,712  
Retained investments from securitizations
    128,896       34,205  
Purchases
    12,646       3,697  
Transfer from investment grade securities
    61,360        
Impairments
    (5,877 )     (846 )
Sales
          (13,542 )
Cash received, net of accretion
    767       369  
Valuation gains (losses) before hedges
    (122,217 )     (1,421 )
                 
Ending balance
  $ 155,748     $ 80,174  
                 
Residual securities(1):
               
Beginning balance
  $ 250,573     $ 167,771  
Retained investments from securitizations, net(2)
    40,178       224,014  
Transfer to prepayment penalty securities
    (3,076 )     200  
Transfer due to clean-up calls and other
    (5,615 )      
Impairments
    (9,778 )     (9,209 )
Sales
          (107,360 )
Clean-up calls exercised
    (2,106 )      
Cash received, net of accretion
    (7,385 )     (22,362 )
Valuation gains (losses) before hedges
    (146,377 )     (2,481 )
                 
Ending balance
  $ 116,414     $ 250,573  
                 
 
 
(1) Included in the residual securities balance at December 31, 2007 were $3.7 million of HELOC residuals retained from two separate guaranteed mortgage securitization transactions. There was no gain on sale of loans recognized in connection with these transactions.
 
(2) Amounts retained consist of 100% in HELOCs for the year ended December 31, 2007.


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TABLE 12.   VALUATION OF MSRs, INTEREST-ONLY, PREPAYMENT PENALTY, AND RESIDUAL SECURITIES
 
MSRs, AAA-rated and agency interest-only securities, prepayment penalty securities, and residual securities are recorded at fair market value. The following presents relevant information and assumptions used to value these securities as of dates indicated (dollars in thousands):
 
                                                                                 
    Actual     Valuation Assumptions  
                Gross Wtd.
    Servicing
    3-Month
    Weighted
    Lifetime
    3-Month
          Remaining
 
          Collateral
    Average
    Fee/Interest
    Prepayment
    Average
    Prepayment
    Prepayment
    Discount
    Cumulative
 
    Book Value     Balance     Coupon     Strip     Speeds     Multiple     Speeds     Speeds     Yield     Loss Rate(1)  
 
                                                                                 
December 31, 2007
                                                                               
                                                                                 
MSRs
  $ 2,495,407     $ 181,723,633       6.89 %     0.34 %     9.7 %     4.01       19.6 %     15.1 %     9.7 %     N/A  
                                                                                 
                                                                                 
AAA-rated interest-only securities
  $ 59,844     $ 5,246,602       6.60 %     0.49 %     8.5 %     2.31       24.5 %     12.9 %     12.3 %     N/A  
                                                                                 
                                                                                 
Prepayment penalty securities
  $ 59,147     $ 18,736,690       7.21 %     N/A       7.0 %     N/A       23.0 %     15.2 %     19.0 %     N/A  
                                                                                 
                                                                                 
Lot loan residual securities
    53,849     $ 1,783,644       9.70 %     4.21 %     27.3 %     1.31       32.5 %     29.2 %     21.8 %     3.18 %
                                                                                 
HELOC residual securities
    30,573     $ 2,693,499       8.40 %     2.58 %     18.3 %     0.44       19.9 %     23.8 %     21.0 %     8.56 %
                                                                                 
Closed-end seconds residual securities
    14,056     $ 1,862,794       10.50 %     3.72 %     11.1 %     0.20       21.4 %     37.8 %     23.1 %     14.6 %
                                                                                 
Subprime residual securities
    17,936     $ 3,670,520       8.60 %     3.03 %     23.5 %     0.16       24.7 %     25.6 %     24.4 %     14.4 %
                                                                                 
                                                                                 
Total non-investment grade residual securities
  $ 116,414                                                                          
                                                                                 
                                                                                 
December 31, 2006
                                                                               
                                                                                 
MSRs
  $ 1,822,455     $ 139,816,763       7.05 %     0.37 %     20.2 %     3.57       25.8 %     19.8 %     8.8 %     N/A  
                                                                                 
                                                                                 
AAA-rated interest-only securities
  $ 73,570     $ 5,957,550       6.93 %     0.51 %     19.5 %     2.41       16.4 %     19.7 %     15.4 %     N/A  
                                                                                 
                                                                                 
Prepayment penalty securities
  $ 97,576     $ 20,282,718       7.40 %     N/A       18.1 %     N/A       28.2 %     20.6 %     26.3 %     N/A  
                                                                                 
                                                                                 
Lot loan residual securities
    57,640     $ 2,246,833       9.24 %     3.54 %     35.6 %     0.73       39.8 %     37.9 %     23.5 %     0.61 %
                                                                                 
HELOC residual securities
    98,697     $ 3,039,555       9.59 %     2.71 %     43.7 %     1.20       50.3 %     47.6 %     20.2 %     1.11 %
                                                                                 
Closed-end seconds residual securities
    14,572     $ 1,737,859       10.44 %     3.69 %     17.5 %     0.23       37.1 %     24.8 %     24.6 %     8.08 %
                                                                                 
Subprime residual securities
    79,664     $ 4,848,859       7.74 %     1.68 %     33.0 %     0.98       39.5 %     38.1 %     20.4 %     5.85 %
                                                                                 
                                                                                 
Total non-investment grade residual securities
  $ 250,573                                                                          
                                                                                 
 
 
(1) As a percentage of the original pool balance, the actual loss rate to date totaled 2.21%, 3.75%, 1.02% and 0.02% for HELOC, closed-end seconds, subprime, and lot loans, respectively, at December 31, 2007.
 
The lifetime prepayment speeds represent the annual constant prepayment rate estimated for the remaining life of the collateral supporting the asset. The prepayment rates are projected using a prepayment model developed by a third-party vendor and calibrated for our collateral. The model considers key factors, such as refinance incentive, housing turnover, seasonality and aging of the pool of loans. Prepayment speeds incorporate expectations of future rates implied by the market forward LIBOR/swap curve, as well as collateral specific current coupon information.
 
The weighted-average multiple for MSRs, AAA-rated and agency interest-only securities and residual securities represent the recorded value divided by the product of collateral balance and servicing fee/interest strip. While the weighted-average life of such assets is a function of the undiscounted cash flows, the multiple is a function of the discounted cash flows. With regard to AAA-rated and agency interest-only securities, the marketplace frequently uses calculated multiples to assess the overall impact valuation assumptions have on value. Collateral type, coupon, loan age and the size of the interest strip must be considered when comparing these multiples. The mix of collateral types supporting servicing-related assets is primarily non-conforming/conventional, which may make our MSR multiples incomparable to peer multiples whose product mix is substantially different.
 
Beginning in the fourth quarter of 2006, the calculation of remaining cumulative loss rate changed to using the remaining lifetime loss projection divided by current collateral balance. All prior periods have been adjusted to reflect such change.


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TABLE 13.   DEPOSITS BY CHANNEL
 
The following shows our deposits by channel as of the dates indicated (dollars in thousands):
 
                                 
    December 31  
    2007     2006  
          % of
          % of
 
          Total
          Total
 
    Amount     Deposits     Amount     Deposits  
 
Deposit Channel
                               
Branch
  $ 6,992,091       40 %   $ 5,211,365       48 %
Internet
    1,588,558       9 %     1,185,423       11 %
Telebanking
    2,017,128       11 %     1,290,595       12 %
Money desk
    6,492,273       36 %     2,593,719       24 %
Custodial
    725,193       4 %     616,904       5 %
                                 
Total deposits
  $ 17,815,243       100 %   $ 10,898,006       100 %
                                 
 
Our deposit products include regular savings accounts, demand deposit accounts, money market accounts, certificates of deposit, and individual retirement accounts. Refer to “Note 9 — Deposits” in the accompanying notes to consolidated financial statements for details of deposit category.
 
TABLE 14.   AVERAGE BALANCE AND RATE OF DEPOSITS BY CATEGORY
 
The following sets forth the average balance of, and the average interest rate paid on deposits, by deposit category for the years indicated (dollars in thousands):
 
                                                 
    Year Ended December 31  
    2007     2006     2005  
    Average
          Average
          Average
       
    Balance     Rate     Balance     Rate     Balance     Rate  
 
Interest-bearing checking
  $ 54,842       1.43 %   $ 52,875       1.26 %   $ 51,487       1.17 %
Savings
    2,322,158       4.89 %     1,539,701       4.64 %     1,302,158       2.88 %
Certificates of deposit
    10,413,494       5.28 %     7,071,201       4.77 %     4,584,502       3.44 %
                                                 
Total interest-bearing deposits
    12,790,494       5.19 %     8,663,777       4.71 %     5,938,147       3.29 %
Non-interest-bearing checking
    75,753       0.00 %     67,681       0.00 %     60,778       0.00 %
Custodial accounts
    804,695       0.00 %     643,124       0.00 %     657,596       0.00 %
                                                 
Total deposits
  $ 13,670,942       4.86 %   $ 9,374,582       4.35 %   $ 6,656,521       2.93 %
                                                 
 
Accrued but unpaid interest on deposits included in other liabilities totaled $1.6 million, $3.8 million and $10.7 million at December 31, 2007, 2006 and 2005, respectively.


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ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Market risk is the exposure to loss resulting from secondary market disruption, changes in interest rates, foreign currency exchange rates, commodity prices and equity prices. The primary market risk to which we are exposed is interest rate risk, including fluctuations in short and long term interest rates. An additional risk is the early prepayment of loans held for investment, MBS and mortgage loans underlying our MSRs, AAA-rated and agency interest-only securities and residuals. Our mortgage servicing division is responsible for the management of interest rate and prepayment risks subject to policies and procedures established by, and oversight from, our management-level Interest Rate Risk Committee, Variable Cash Flow Instruments Committee, management level ERM group and Board of Directors-level ERM Committee. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Risk Factors That May Affect Future Results” above for further discussion of risks.
 
We utilize a variety of means in order to manage interest rate risk. We invest in MSRs and AAA-rated and agency interest-only securities to generate core interest and fee income. The value of these instruments and the income they provide tends to be counter-cyclical to the changes in production volumes and gain on sale of loans that result from changes in interest rates. With regard to the pipeline of mortgage loans held for sale, in general, we hedge this asset with forward commitments to sell Fannie Mae or Freddie Mac securities of comparable maturities and weighted average interest rates. To hedge our investments in MSRs, AAA-rated and agency interest-only and residual securities, we use several strategies, including buying and/or selling mortgage-backed or U.S. Treasury securities, forward rate agreements, futures, floors, swaps, or options, depending on several factors. Lastly, we enter into swap agreements and utilize FHLB advances to mitigate interest rate risk on mortgage loans and securities held for investment. In connection with all of the above strategies, we use hedging instruments to reduce our exposure to interest rate risk, not to speculate on the direction of market interest rates.
 
The primary measurement tools used to evaluate risk include value at risk, duration gap, and NPV analysis. These tools attempt to measure the sensitivity of our assets and liabilities to various changes in interest rates. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Consolidated Risk Management Discussion — CAMELS Framework for Risk Management — Sensitivity to Market Risk” for a further discussion of our measurement tools used to analyze interest rate risk.
 
ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
The information called for by this Item 8 is set forth beginning at page F-1 of this Form 10-K.
 
ITEM 9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
 
None.
 
ITEM 9A.   CONTROLS AND PROCEDURES
 
The management of Indymac is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15 and 15d-15 of the Securities Exchange Act of 1934. As of December 31, 2007, an evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of Indymac’s disclosure controls and procedures. Based on that evaluation, management concluded that Indymac’s disclosure controls and procedures as of December 31, 2007 were effective in ensuring that information required to be disclosed in this Annual Report on Form 10-K (“Annual Report”) was recorded, processed, summarized, and reported within the time period required by the SEC’s rules and forms.
 
Management’s responsibilities related to establishing and maintaining effective disclosure controls and procedures include maintaining effective internal controls over financial reporting that are designed to produce reliable financial statements in accordance with accounting principles generally accepted in the United States. As disclosed in the Report of Management on Internal Control over Financial Reporting (“Report of Management”) included in this Annual Report, management assessed the Company’s internal control over financial reporting as of


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December 31, 2007, in relation to criteria for effective internal control over financial reporting as described in “Internal Control — Integrated Framework”, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management concluded the Company’s internal control over financial reporting is effective as of December 31, 2007. The independent registered public accounting firm that audited the financial statements included in this Annual Report has issued an attestation report of the Company’s effectiveness of internal control over financial reporting as of December 31, 2007. The Report of Management and the attestation report are included in this Annual Report under Exhibit 99.1 “Reports on Internal Control Over Financial Reporting”.
 
There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect the Company’s disclosure of controls and procedures subsequent to December 31, 2007.
 
ITEM 9B.   OTHER INFORMATION
 
None.
 
PART III
 
ITEM 10.   DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 
The information required by this Item 10 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 2007 fiscal year.
 
ITEM 11.   EXECUTIVE COMPENSATION
 
The information required by this Item 11 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 2007 fiscal year.
 
ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
 
The information required by this Item 12 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 2007 fiscal year.
 
ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
The information required by this Item 13 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 2007 fiscal year.
 
ITEM 14.   PRINCIPAL ACCOUNTING FEES AND SERVICES
 
The information required by this Item 14 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 2007 fiscal year.
 
PART IV
 
ITEM 15.   EXHIBITS, FINANCIAL STATEMENT SCHEDULES
 
(a) (1) and (2) — Financial Statements and Schedules
 
The information required by this section of Item 15 is set forth in the Index to Consolidated Financial Statements at page F-2 of this Form 10-K.
 
(3) — Exhibits
 


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Exhibit
   
No.
 
Description
 
  3 .1*   Restated Certificate of Incorporation of IndyMac Bancorp, Inc. (incorporated by reference to Exhibit 3.1 to IndyMac Bancorp’s Form 10-Q for the quarter ended September 30, 2000).
  3 .2*   Amended and Restated Bylaws of IndyMac Bancorp, Inc. (incorporated by reference to Exhibit 3.1 to IndyMac Bancorp’s Form 8-K filed with the SEC on September 21, 2007).
  4 .1*   Indenture dated as of November 14, 2001 between IndyMac Bancorp and The Bank of New York (“BoNY”), as Trustee (incorporated by reference to Exhibit 4.8 to IndyMac Bancorp’s Form 10-K for the year ended December 31, 2001).
  4 .2*   First Supplemental Indenture dated as of November 14, 2001 between IndyMac Bancorp and BoNY, as Trustee (incorporated by reference to Exhibit 4.9 to IndyMac Bancorp’s Form 10-K for the year ended December 31, 2001).
  4 .3*   Rights Agreement dated as of October 17, 2001 between IndyMac Bancorp and BoNY, as Rights Agent (incorporated by reference to Exhibit 4.1 to IndyMac Bancorp’s Form 8-K filed with the SEC on October 18, 2001).
  10 .1*   Amended and Restated Trust Agreement dated as of November 14, 2001 between IndyMac Bancorp, as Sponsor, Roger H. Molvar and Richard L. Sommers, as Administrative Trustees, Wilmington Trust Company, as Property Trustee and as Delaware Trustee, BoNY, as Paying Agent, Registrar, Transfer Agent and Authenticating Agent and several Holders of the Securities (incorporated by reference to Exhibit 10.11 to IndyMac Bancorp’s Form 10-K for the year ended December 31, 2001).
  10 .2*   Unit Agreement dated as of November 14, 2001 between IndyMac Bancorp, IndyMac Capital Trust I, Wilmington Trust Company, as Property Trustee, and BoNY, as Agent (incorporated by reference to Exhibit 10.12 to IndyMac Bancorp’s Form 10-K for the year ended December 31, 2001).
  10 .3*   Warrant Agreement dated as of November 14, 2001 between IndyMac Bancorp and BoNY, as Warrant Agent (incorporated by reference to Exhibit 10.13 to IndyMac Bancorp’s Form 10-K for the year ended December 31, 2001).
  10 .4*   Guarantee Agreement dated as of November 14, 2001 between IndyMac Bancorp, as Guarantor, and BoNY, as Guarantee Trustee (incorporated by reference to Exhibit 10.14 to IndyMac Bancorp’s Form 10-K for the year ended December 31, 2001).
  10 .5*   IndyMac Bancorp, Inc. Cash Incentive Award Program Under the 2002 Incentive Plan, As Amended and Restated (incorporated by reference to Exhibit 10.2 to IndyMac Bancorp’s Form 10-Q for the quarter ended September 30, 2004).
  10 .6*   Form of Director Indemnification Agreement (incorporated by reference to Exhibit 10.1 to IndyMac Bancorp’s Form 10-Q for the quarter ended March 31, 2006).
  10 .7*   Employment Agreement entered into May 23, 2006 between IndyMac Bank, F.S.B. and Charles A. Williams (incorporated by reference to Exhibit 10.6 to IndyMac Bancorp’s Form 8-K filed with the SEC on May 30, 2006).
  10 .8*   IndyMac Bancorp, Inc. Amended Director Emeritus Plan effective as of May 24, 2006 (incorporated by reference to Exhibit 10.2 to IndyMac Bancorp’s Form 10-Q for the quarter ended June 30, 2006).
  10 .9*   Amended and Restated Employment Agreement entered into July 1, 2006 between IndyMac Bank, F.S.B. and James R. Mahoney (incorporated by reference to Exhibit 10.1 to IndyMac Bancorp’s Form 8-K filed with the SEC on July 5, 2006).
  10 .10*   Letter Agreement entered into July 1, 2006 between IndyMac Bank, F.S.B. and James R. Mahoney (incorporated by reference to Exhibit 10.2 to IndyMac Bancorp’s Form 8-K filed with the SEC on July 5, 2006).
  10 .11*   Form of Director’s Agreement, effective August 1, 2006 (incorporated by reference to Exhibit 10.1 to IndyMac Bancorp’s Form 8-K filed with the SEC on August 2, 2006).
  10 .12*   Summary of Terms of Stock Option Awards Granted to Executive Officers (incorporated by reference to Exhibit 10.25 to Indymac Bancorp’s Form 10-K for the year ended December 31, 2006).
  10 .13*   2000 Stock Incentive Plan, as Amended (incorporated by reference to Exhibit 4.1 to IndyMac Bancorp’s Form 10-Q for the quarter ended September 30, 2007).

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Exhibit
   
No.
 
Description
 
  10 .14*   2002 Incentive Plan, as Amended and Restated (incorporated by reference to Exhibit 4.2 to IndyMac Bancorp’s Form 10-Q for the quarter ended September 30, 2007).
  10 .15*   IndyMac Bancorp, Inc. Senior Manager and Non-Employee Director Deferred Compensation Plan Amended and Restated on September 17, 2007 (incorporated by reference to Exhibit 10.3 to IndyMac Bancorp’s Form 10-Q for the quarter ended September 30, 2007).
  10 .16*   IndyMac Bank, F.S.B. Deferred Compensation Plan, Amended and Restated Effective as of January 1, 2008 (incorporated by reference to Exhibit 10.2 to IndyMac Bancorp’s Form 10-Q for the quarter ended September 30, 2007).
  10 .17   Amended Director Compensation and Stock Ownership Policy Requirements, revised January 29, 2008.
  10 .18   Employment Agreement entered into May 23, 2006 between IndyMac Bank, F.S.B. and S. Blair Abernathy, as amended effective January 29, 2008.
  10 .19   Employment Agreement entered into May 23, 2006 between IndyMac Bank, F.S.B. and Ashwin Adarkar, as amended effective January 29, 2008.
  10 .20   Employment Agreement entered into May 23, 2006 between IndyMac Bank, F.S.B. and Scott Keys, as amended effective January 29, 2008.
  10 .21   Employment Agreement entered into May 23, 2006 between IndyMac Bank, F.S.B. and Frank M. Sillman, as amended effective January 29, 2008.
  10 .22   Amended and Restated Employment Agreement entered into September 17, 2007 between IndyMac Bancorp and Michael W. Perry, as further amended on February 15, 2008.
  10 .23   Amended and Restated Employment Agreement entered into September 17, 2007 between IndyMac Bank, F.S.B. and Richard Wohl, as further amended on February 15, 2008.
  21 .1   List of Subsidiaries.
  23 .1   Consent of Independent Registered Public Accounting Firm.
  31 .1   Chief Executive Officer’s Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31 .2   Chief Financial Officer’s Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  32 .1   Chief Executive Officer’s Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  32 .2   Chief Financial Officer’s Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  99 .1   Reports on Internal Control Over Financial Reporting.
 
 
* Incorporated by reference.

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SIGNATURES
 
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Pasadena, State of California, on February 29, 2008.
 
INDYMAC BANCORP, INC.
(Registrant)
 
  By: 
/s/  MICHAEL W. PERRY
Michael W. Perry
Chairman of the Board of Directors
and Chief Executive Officer
 
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant in the capacities and on the dates indicated.
 
             
Signature
 
Title
 
Date
   
 
             
/s/  Michael W. Perry

Michael W. Perry
  Chairman of the Board of Directors
Chief Executive Officer
(Principal Executive Officer)
  February 29, 2008    
             
/s/  Scott Keys

Scott Keys
  Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
  February 29, 2008    
             
/s/  Louis E. Caldera

Louis E. Caldera
  Director   February 29, 2008    
             
/s/  Lyle E. Gramley

Lyle E. Gramley
  Director   February 29, 2008    
             
/s/  Hugh M. Grant

Hugh M. Grant
  Director   February 29, 2008    
             
/s/  Patrick C. Haden

Patrick C. Haden
  Director   February 29, 2008    
             
/s/  Terrance G. Hodel

Terrance G. Hodel
  Director   February 29, 2008    
             
/s/  Robert L. Hunt II

Robert L. Hunt II
  Director   February 29, 2008    
             
/s/  Lydia H. Kennard

Lydia H. Kennard
  Director   February 29, 2008    
             
/s/  Senator John Seymour (ret.)

Senator John Seymour (ret.)
  Director   February 29, 2008    
             
/s/  Bruce G. Willison

Bruce G. Willison
  Director   February 29, 2008    


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CONSOLIDATED FINANCIAL STATEMENTS AND
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
INDYMAC BANCORP, INC.
AND SUBSIDIARIES
 
December 31, 2007, 2006 and 2005
 


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Table of Contents

INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2007, 2006 and 2005
 
         
    Page
 
    F-3  
Consolidated Financial Statements
       
    F-4  
    F-5  
    F-6  
    F-7  
    F-8  


F-2


Table of Contents

 
Report of Independent Registered Public Accounting Firm
 
Board of Directors and Shareholders
IndyMac Bancorp, Inc.
 
We have audited the accompanying consolidated balance sheets of IndyMac Bancorp, Inc. and subsidiaries (the Company) as of December 31, 2007 and 2006, and the related consolidated statements of operations, shareholders’ equity and comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2007. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company at December 31, 2007 and 2006, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles.
 
As discussed in Notes 1 and 7 to the consolidated financial statements, on January 1, 2006, the Company changed its method of accounting for share-based payments in accordance with Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, under the modified-retrospective transition method, and its method of accounting for mortgage servicing rights in accordance with Statement of Financial Accounting Standards No. 156, Accounting for Servicing of Financial Assets, an amendment of FASB Statement No. 140.
 
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 28, 2008 expressed an unqualified opinion thereon.
 
/s/ Ernst & Young LLP
 
Los Angeles, California
February 28, 2008


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
 
                 
    December 31  
    2007     2006  
 
ASSETS
Cash and cash equivalents
  $ 561,832     $ 541,725  
Securities classified as trading
    1,222,543       542,731  
Securities classified as available for sale
    6,105,976       4,900,514  
Loans held for sale
    3,776,904       9,467,843  
Loans held for investment, net of allowance for loan losses of $398,135 and $62,386 at December 31, 2007 and 2006, respectively
    16,055,911       10,114,823  
Mortgage servicing rights
    2,495,407       1,822,455  
Other assets
    2,515,895       2,105,225  
                 
Total assets
  $ 32,734,468     $ 29,495,316  
                 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
               
Deposits
  $ 17,815,243     $ 10,898,006  
Advances from Federal Home Loan Bank
    11,188,800       10,412,800  
Other borrowings
    652,778       4,637,000  
Other liabilities
    1,242,509       1,519,242  
                 
Total liabilities
    30,899,330       27,467,048  
                 
                 
                 
Perpetual preferred stock in subsidiary
    491,314        
                 
                 
Shareholders’ Equity:
               
Preferred stock — authorized, 10,000,000 shares of $0.01 par value; none issued
           
Common stock — authorized, 200,000,000 shares of $0.01 par value; issued 108,860,912 shares and 102,258,939 shares at December 31, 2007 and 2006, respectively
    1,089       1,023  
Additional paid-in-capital, common stock
    1,750,419       1,597,814  
Accumulated other comprehensive loss
    (139,221 )     (31,439 )
Retained earnings
    238,972       983,348  
Treasury stock
    (507,435 )     (522,478 )
                 
Total shareholders’ equity
    1,343,824       2,028,268  
                 
Total liabilities and shareholders’ equity
  $ 32,734,468     $ 29,495,316  
                 
 
The accompanying notes are an integral part of these consolidated financial statements.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share data)
 
                         
    Year Ended December 31  
    2007     2006     2005  
 
Interest income
                       
Mortgage-backed and other securities
  $ 406,376     $ 319,846     $ 208,560  
Loans held for sale
    994,886       797,460       430,857  
Loans held for investment
    712,783       585,738       405,855  
Other
    73,662       47,972       29,083  
                         
Total interest income
    2,187,707       1,751,016       1,074,355  
                         
Interest expense
                       
Deposits
    663,217       408,208       195,528  
Advances from Federal Home Loan Bank
    701,226       491,300       281,929  
Other borrowings
    256,522       324,787       172,187  
                         
Total interest expense
    1,620,965       1,224,295       649,644  
                         
Net interest income
    566,742       526,721       424,711  
Provision for loan losses
    395,548       19,993       9,978  
                         
Net interest income after provision for loan losses
    171,194       506,728       414,733  
Non-interest income (loss)
                       
Gain (loss) on sale of loans
    (354,360 )     668,054       592,175  
Service fee income
    519,253       101,317       44,235  
Gain (loss) on mortgage-backed securities
    (439,713 )     20,482       17,866  
Fee and other income
    107,190       50,122       36,701  
                         
Total non-interest income (loss)
    (167,630 )     839,975       690,977  
                         
Net revenues
    3,564       1,346,703       1,105,710  
Non-interest expense
    975,411       790,083       619,088  
                         
Earnings (loss) before provision (benefit) for income taxes and minority interests
    (971,847 )     556,620       486,622  
Provision (benefit) for income taxes
    (380,060 )     212,567       191,989  
                         
Net earnings (loss) before minority interests
    (591,787 )     344,053       294,633  
Minority interests
    (23,021 )     (1,124 )     (1,505 )
                         
Net earnings (loss)
  $ (614,808 )   $ 342,929     $ 293,128  
                         
Earnings (loss) per share:
                       
Basic
  $ (8.28 )   $ 5.07     $ 4.67  
Diluted(1)
  $ (8.28 )   $ 4.82     $ 4.43  
Weighted average shares outstanding:
                       
Basic
    74,261       67,701       62,760  
Diluted(1)
    74,261       71,118       66,115  
Dividends declared per share
  $ 1.75     $ 1.88     $ 1.56  
 
 
(1) Due to the net loss for the year ended December 31, 2007, no potentially dilutive shares are included in the diluted loss per share calculation as including such shares in the calculation would be anti-dilutive.
 
The accompanying notes are an integral part of these consolidated financial statements.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
AND COMPREHENSIVE INCOME (LOSS)
(Dollars in thousands)
 
                                                         
                      Accumulated
                   
                Additional
    Other
                Total
 
    Shares
    Common
    Paid-In-
    Comprehensive
    Retained
    Treasury
    Shareholders’
 
    Outstanding     Stock     Capital     Loss     Earnings     Stock     Equity  
 
Balance at December 31, 2004, retrospectively adjusted
    61,995,480     $ 912     $ 1,254,793     $ (20,304 )   $ 564,705     $ (519,835 )   $ 1,280,271  
Comprehensive income:
                                                       
Net earnings, retrospectively adjusted
                            293,128             293,128  
Other comprehensive income (loss), net of tax:
                                                       
Net unrealized loss on mortgage-backed securities available for sale
                      (16,733 )                 (16,733 )
Net unrealized gain on derivatives used in cash flow hedges
                      21,880                   21,880  
                                                         
Total comprehensive income
                                        298,275  
                                                         
Exercises of common stock options
    1,833,369       18       43,435                         43,453  
Exercises of warrants
    138,794       1       3,035                         3,036  
Compensation expenses for common stock options
                12,109                         12,109  
Net officers’ notes receivable payments
                101                         101  
Deferred compensation and restricted stock amortization, net of forfeitures
    295,544       3       5,278                         5,281  
Purchases of common stock
    (16,420 )                             (582 )     (582 )
Cash dividends
                            (98,503 )           (98,503 )
                                                         
Balance at December 31, 2005, retrospectively adjusted
    64,246,767       934       1,318,751       (15,157 )     759,330       (520,417 )     1,543,441  
Comprehensive income:
                                                       
Net earnings
                            342,929             342,929  
Other comprehensive income (loss), net of tax:
                                                       
Net unrealized gain on mortgage-backed securities available for sale
                      5,921                   5,921  
Net unrealized loss on derivatives used in cash flow hedges
                      (16,035 )                 (16,035 )
                                                         
Total comprehensive income
                                        332,815  
                                                         
Cumulative-effect adjustment due to change in accounting for MSRs
                            10,624             10,624  
Adjustment on initial application of SFAS 158, net of tax
                      (6,168 )                 (6,168 )
Issuance of common stock
    3,532,360       35       148,435                         148,470  
Exercises of common stock options
    857,489       9       23,486                         23,495  
Exercises of warrants
    3,957,000       40       86,883                         86,923  
Compensation expenses for common stock options
                9,630                         9,630  
Net officers’ notes receivable payments
                109                         109  
Deferred compensation and restricted stock amortization, net of forfeitures
    475,468       5       10,520                         10,525  
Purchases of common stock
    (51,728 )                             (2,061 )     (2,061 )
Cash dividends
                            (129,535 )           (129,535 )
                                                         
Balance at December 31, 2006
    73,017,356       1,023       1,597,814       (31,439 )     983,348       (522,478 )     2,028,268  
Comprehensive loss:
                                                       
Net loss
                              (614,808 )           (614,808 )
Other comprehensive income (loss), net of tax:
                                                       
Net unrealized loss on mortgage-backed securities available for sale
                      (97,769 )                 (97,769 )
Net unrealized loss on derivatives used in cash flow hedges
                      (14,922 )                 (14,922 )
Change in pension liability
                      4,909                   4,909  
                                                         
Total comprehensive loss
                                                    (722,590 )
                                                         
Issuance of common stock
    7,427,104       74       145,514                         145,588  
Exercises of common stock options
    145,033             1                   2,591       2,592  
Exercises of warrants
    63,888       1       1,405                         1,406  
Compensation expense for common stock options
                7,943                         7,943  
Net officers’ notes receivable payments
                342                         342  
Deferred compensation and restricted stock amortization, net of forfeitures
    275,272       (9 )     (2,600 )                 14,009       11,400  
Purchases of common stock
    (43,232 )                             (1,557 )     (1,557 )
Cash dividends
                            (129,568 )           (129,568 )
                                                         
Balance at December 31, 2007
    80,885,421     $ 1,089     $ 1,750,419     $ (139,221 )   $ 238,972     $ (507,435 )   $ 1,343,824  
                                                         
 
The accompanying notes are an integral part of these consolidated financial statements.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
 
                         
    Year Ended December 31  
    2007     2006     2005  
 
Cash flows from operating activities:
                       
Net (loss) earnings
  $ (614,808 )   $ 342,929     $ 293,128  
Adjustments to reconcile net (loss) earnings to net cash used in operating activities:
                       
Loss (gain) on sale of loans
    354,360       (668,054 )     (592,175 )
Compensation expenses related to stock options and restricted stock
    19,343       20,155       17,389  
Other amortization and depreciation
    126,914       93,515       59,393  
Change in valuation of mortgage servicing rights
    (1,120 )     367,234       269,586  
Loss (gain) on mortgage-backed securities, net
    439,714       (20,482 )     (17,866 )
Provision for loan losses
    395,548       19,993       9,978  
(Benefit) provision for deferred income taxes
    (380,060 )     245,115       166,369  
Net (increase) decrease in other assets and liabilities
    134,272       90,012       17,110  
                         
Net cash provided by operating activities before activity for trading securities and loans held for sale
    474,163       490,417       222,912  
Net (purchases) sales of trading securities
    (436,971 )     360,547       109,721  
Net (purchases and origination) sales of loans held for sale
    (7,530,130 )     (8,253,670 )     (4,909,424 )
                         
Net cash used in operating activities
    (7,492,938 )     (7,402,706 )     (4,576,791 )
                         
Cash flows from investing activities:
                       
(Additions to) repayments of loans held for investment, net
    (857,854 )     (157,373 )     176,639  
Proceeds from sale of loans held for investment
    3,304,640       1,147,292       932,378  
Purchases of mortgage-backed securities available for sale
    (622,347 )     (1,170,559 )     (819,997 )
Proceeds from sales of and principal payments from mortgage-backed securities available for sale
    1,438,804       997,623       822,748  
Net decrease (increase) in investment in FHLB stock, at cost
    85,977       (205,792 )     (165,546 )
Net (increase) decrease in real estate investment
    (1,009 )     10,780       (32,260 )
Net sale (purchases) of property, plant and equipment
    28,610       (99,947 )     (109,076 )
Purchase of Financial Freedom minority interest
          (40,000 )      
                         
Net cash provided by investing activities
    3,376,821       482,024       804,886  
                         
Cash flows from financing activities:
                       
Net increase in deposits
    6,908,823       3,222,155       1,925,557  
Net increase in advances from Federal Home Loan Bank
    776,000       3,459,800       791,000  
Net (decrease) increase in borrowings
    (4,040,448 )     69,797       1,104,208  
Net proceeds from issuance of common stock
    145,588       148,470        
Net proceeds from issuance of trust preferred securities
    30,000       188,000       90,000  
Redemption of trust preferred securities
    (48,268 )     (47,271 )      
Net proceeds from stock options, warrants, and notes receivable
    4,340       110,527       46,591  
Proceeds from issuance of preferred stock by subsidiary
    491,314              
Cash dividends paid
    (129,568 )     (129,535 )     (98,501 )
Purchases of common stock
    (1,557 )     (2,061 )     (582 )
                         
Net cash provided by financing activities
    4,136,224       7,019,882       3,858,273  
                         
Net increase in cash and cash equivalents
    20,107       99,200       86,368  
Cash and cash equivalents at beginning of year
    541,725       442,525       356,157  
                         
Cash and cash equivalents at end of year
  $ 561,832     $ 541,725     $ 442,525  
                         
Supplemental cash flow information:
                       
Cash paid for interest
  $ 1,546,637     $ 1,168,615     $ 600,683  
                         
Cash paid (received) for income taxes
  $ 12,185     $ (56,258 )   $ 70,312  
                         
Supplemental disclosure of non-cash investing and financing activities:
                       
Net transfer of loans held for sale to loans held for investment
  $ 10,240,773     $ 2,951,131     $ 2,691,949  
                         
Net transfer of loans held for investment to loans held for sale
  $ 1,865,072     $ 957,563     $ 849,689  
                         
Net transfer of mortgage servicing rights to trading securities
  $ 54,993     $ 4,723     $ 8,491  
                         
 
The accompanying notes are an integral part of these consolidated financial statements.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Financial Statement Presentation
 
IndyMac Bancorp, Inc. is a savings and loan holding company. References to “IndyMac Bancorp” or the “Parent Company” refer to the parent company alone while references to “Indymac,” the “Company,” “we” or “us” refer to Indymac Bancorp and its consolidated subsidiaries.
 
The consolidated financial statements include the accounts of Indymac Bancorp and all of its wholly-owned and majority-owned subsidiaries, including IndyMac Bank, F.S.B. (“Indymac Bank” or “Bank”) and variable interest entities. All significant intercompany balances and transactions with Indymac’s consolidating subsidiaries have been eliminated in consolidation. Minority interests and perpetual preferred stock in Indymac’s majority-owned subsidiaries or variable interest entities are either reported separately or included in other liabilities on the consolidated balance sheets. Minority interests in Indymac’s earnings are reported separately on the consolidated statements of operations.
 
The consolidated financial statements of Indymac are prepared in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”). Certain prior year amounts have been reclassified to conform to the current year presentation.
 
Use of Estimates
 
The preparation of these consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Significant estimates include the allowance for loan losses (“ALL”), lower of cost or market (“LOCOM”) on loans held for sale, secondary market reserves and the valuation of our hedging instruments, mortgage servicing rights (“MSRs”), AAA-rated and agency interest-only and principal-only securities, late fee securities, prepayment penalty securities, non-investment grade securities and residual interests for which active markets do not exist. Actual results may differ significantly from those estimates and assumptions.
 
New Accounting Pronouncements
 
In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), an interpretation of FASB Statement No. 109, “Accounting for Income Taxes”. FIN 48 clarifies the accounting and reporting for income taxes where interpretation of the law is uncertain. FIN 48 prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of income tax uncertainties with respect to positions taken or expected to be taken in income tax returns. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company adopted this Statement on January 1, 2007 and recognizes interest and penalties in other expense. The adoption of FIN 48 did not have a material impact on the consolidated financial statements.
 
In September 2006, the FASB issued Statement No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under U.S. GAAP. SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 is effective prospectively for fiscal years beginning after November 15, 2007. The Company will adopt SFAS 157 prospectively on January, 1, 2008, with no cumulative-effect adjustment to beginning retained earnings.
 
In February 2007, the FASB issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 would allow the Company an irrevocable election to measure certain financial assets and liabilities at fair value, with unrealized gains and losses on the elected items recognized


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
in earnings at each reporting period. The fair value option may only be elected at the time of initial recognition of a financial asset or financial liability or upon the occurrence of certain specified events. The election is applied on an instrument by instrument basis, with a few exceptions, and is applied only to entire instruments and not to portions of instruments. SFAS 159 also provides expanded disclosure requirements regarding the effects of electing the fair value option on the financial statements. SFAS 159 is effective prospectively for fiscal years beginning after November 15, 2007. The Company intends to elect the fair value option effective January 1, 2008 for certain existing and new loans held for sale, including reverse mortgage loans. This adoption will not have a material impact on the consolidated financial statements.
 
In April 2007, the FASB issued FSP No. FIN 39-1, “Amendment of FASB Interpretation No. 39” (“FSP 39-1”). FSP 39-1 amends FIN No. 39, “Offsetting of Amounts Related to Certain Contracts” (“FIN 39”), to permit a reporting entity to offset fair value amounts recognized for the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) against fair value amounts recognized for derivative instruments executed with the same counterparty under the same master netting arrangement offset in accordance with FIN 39. FSP 39-1 also amends FIN 39 for certain terminology modifications. FSP 39-1 is effective for fiscal years beginning after November 15, 2007, with early application permitted. Upon adoption of FSP 39-1, a reporting entity is permitted to change its accounting policy to offset or not offset fair value amounts recognized for derivative instruments under master netting arrangements. The Company adopted FSP 39-1 on September 30, 2007 and elected to offset derivative instruments executed with the same counterparty under the same master netting arrangement and to net cash collateral paid or collected in accordance with FSP 39-1. The adoption of FSP 39-1 did not have a material impact on the consolidated financial statements.
 
In October 2007, the Securities Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 109, “Written Loan Commitments Recorded at Fair Value Through Earnings” (“SAB 109”). SAB 109 supersedes SAB No. 105, “Application of Accounting Principles to Loan Commitments” (“SAB 105”), to provide guidance regarding written loan commitments accounted for at fair value through earnings. The SEC determined the expected net future cash flows related to the associated servicing of the loan should be included in the measurement of all written loan commitments that are accounted for at fair value through earnings. The Company will adopt SAB 109 prospectively for derivative loan commitments issued or modified beginning January 1, 2008. This adoption will not have a material impact on the consolidated financial statements.
 
In December 2007, the FASB issued Statement No. 141 (revised 2007), “Business Combinations” (“SFAS 141(R)”), which requires an acquiring entity to recognize, with certain exceptions, the fair value of the acquired entity as a whole, regardless of the percentage ownership in the acquired entity or how the acquisition was achieved. This Statement also recognizes contingent consideration arrangements at their acquisition-date fair values, with subsequent changes in fair value generally reflected in earnings. SFAS 141(R) is effective for business combination transactions for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, with early adoption prohibited. The Company will adopt this Statement on January 1, 2009.
 
In December 2007, the FASB issued Statement No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (“SFAS 160”), an amendment of Accounting Research Bulletin No. 51, “Consolidated Financial Statements.” SFAS 160 is based on the economic entity concept of consolidated financial statements, and all residual economic interest holders in an entity have an equity interest in the consolidated equity, even if the residual interest is relative to only a portion of the entity. This Statement requires the presentation of noncontrolling interests and controlling interests as separate components of equity in the consolidated statement of financial position with disclosures about attributes and transactions pertaining to noncontrolling interests. SFAS 160 also requires that earnings attributed to the noncontrolling interests are to be recorded as part of consolidated earnings and not as a separate component of income or expense. The Statement requires disclosure of the attribution of consolidated earnings to the controlling and noncontrolling interests on the consolidated income statement. SFAS 160 is effective for fiscal years beginning after December 15, 2008, with early adoption prohibited. SFAS 160 is required to be


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
adopted prospectively, except for certain provisions which are required to be adopted retrospectively. The Company will adopt this Statement on January 1, 2009, and is assessing the impact of the adoption of this Statement.
 
Cash and Cash Equivalents
 
Cash and cash equivalents include non-restricted cash on deposit and overnight investments.
 
Mortgage-Backed Securities
 
Mortgage-backed securities (“MBS”) consist of AAA-rated senior securities, investment and non-investment grade securities, AAA-rated and agency interest-only and principal-only securities, prepayment penalty securities, late fee securities, residual securities, and agency notes. AAA-rated interest-only securities, prepayment penalty securities, late fee securities, and residual securities, as well as the securities that the Company considers as hedges of its AAA-rated interest-only securities, residual securities and MSRs, are carried as trading securities. All other MBS are classified as available for sale, including home equity lines of credit (“HELOCs”) residual securities created in two separate securitization transactions through which HELOCs loans were recharacterized as securities available for sale. All securities are carried at fair value, which is estimated based on market quotes, when available, or on discounted cash flow techniques using assumptions for prepayment rates, market yield requirements and credit losses when market quotes are not available. We estimate future prepayment rates based upon current and expected future interest rate levels, collateral seasoning and market forecasts, as well as relevant characteristics of the collateral underlying the assets, such as loan types, prepayment penalties, interest rates and recent prepayment experience. These assumptions are estimates as of a specific point in time and will change as interest rates or economic conditions change. Premiums or discounts on securities available for sale are amortized or accreted into income using the effective interest method.
 
Securities classified as trading are carried at fair value with changes in fair value being recorded through current earnings. Unrealized gains and losses resulting from fair value adjustments on investment securities and MBS available for sale are excluded from earnings and reported as a separate component of other comprehensive income (“OCI”), net of taxes, in shareholders’ equity. If we determine a decline in fair value of an available for sale security is other than temporary, an impairment write-down is recognized in current earnings. Realized gains and losses are calculated using the specific identification method.
 
Loans Held for Sale
 
Loans held for sale (“HFS”) consist primarily of residential mortgage loans, which are secured by one-to-four family residential real estate located throughout the United States. We originate and purchase mortgage loans generally with the intent to sell them in the secondary market. Loans HFS are carried at the lower of aggregate cost, net of purchase discounts or premiums, deferred fees, deferred origination costs and effects of hedge accounting, or fair value. Historically, the fair value of loans HFS was determined using current secondary market prices for loans with similar coupons, maturities and credit quality. Given recent market disruptions, these current secondary market prices generally relied on to value HFS loans were not available. As a result, the Company considered other factors, including: 1) quoted market prices for to be announced (“TBA”) securities (for agency-eligible loans); 2) recent transaction settlements or traded but unsettled transactions for similar assets; 3) recent third party market transactions for similar assets; and 4) modeled valuations using assumptions the Company believes a reasonable market participant would use in valuing similar assets (assumptions may include loss rates, prepayment rates, interest rates, volatilities, mortgage spreads). At December 31, 2007, the majority of the Company’s loans HFS are GSE-eligible. As these loans have reliable market price information, the fair value of these loans continues to be based on quoted market prices of similar assets. For the non eligible for sale to Government Sponsored Enterprises (“GSEs”) loans, including loans transferred to held for investment at the lower of cost or fair value, the valuation of these loans necessarily requires more reliance on recent third party market transactions for similar assets and


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
modeled valuations using assumptions the Company believes a reasonable market participant would use in valuing similar assets.
 
Since there was very limited available price discovery due to the collapse of the secondary market for non-GSE mortgages, the estimation of fair value in the second half of 2007 required significant management judgment.
 
While management believes its determination of fair values is reasonable in the circumstances, even small changes in the underlying assumptions, application of different valuation approaches or a different assessment of the weight of evidence from the available sources of information could have resulted in significantly different estimates.
 
The Company adopted SAB 105 on April 1, 2004 and will adopt SAB 109 on January 1, 2008 on a prospective basis. In accordance with SAB 105, the Company no longer recognizes any revenue at the inception of a rate lock commitment, and thus excludes the day one value on rate lock commitments from the fair value of loans HFS. Initial value inherent in the rate lock commitments at origination is recognized at the time of the sale of the underlying loans. Upon adoption of SAB 109, the Company will recognize revenue at the inception of a rate lock commitment.
 
The fair value of mortgage loans is subject to change primarily due to changes in market interest rates. Under our risk management policy, we hedge the changes in fair value of our loans HFS primarily by selling forward contracts on agency securities. We formally designate and document certain of these hedging relationships as fair value hedges and record the changes in the fair value of hedged loans HFS, as an adjustment to the carrying basis of the loan through gain on sale of loans in current earnings. We record the related hedging instruments at fair value with changes in fair value also recorded in gain on sale of loans in current earnings. The non-designated pipeline hedges are recorded at fair value in gain on sale of loans.
 
As part of our mortgage banking operations, we enter into commitments to purchase or originate loans whereby the interest rate on the loans is determined prior to funding (“rate lock commitments”). We report rate lock commitments on loans we intend to sell as derivatives as defined in SFAS 133 and determine the fair value of rate lock commitments using current secondary market prices for underlying loans with similar coupons, maturity and credit quality, subject to the anticipated loan funding probability, or fallout factor. Similar to loans HFS, the fair value of rate lock commitments is subject to change primarily due to changes in interest rates. In addition, the value of rate lock commitments is affected by changes in the anticipated loan funding probability or fallout factor. Under our risk management policy, we hedge these changes in fair value primarily by selling forward contracts on agency securities. Both the rate lock commitments and the related hedging instruments are recorded at fair value with changes in fair value being recorded in gain on sale of loans in current earnings.
 
Our recognition of gain or loss on the sale of loans is accounted for in accordance with FASB Statement No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” (“SFAS 140”). SFAS 140 requires that a transfer of financial assets in which we surrender control over the assets be accounted for as a sale to the extent that consideration other than beneficial interests in the transferred assets is received in exchange. The carrying value of the assets sold is allocated between the assets sold and the retained interests based on their relative fair values.
 
SFAS 140 requires, for certain transactions completed after the initial adoption date, a “true sale” analysis of the treatment of the transfer under state law as if the Company was a debtor under the bankruptcy code. A “true sale” legal analysis includes several legally relevant factors, such as the nature and level of recourse to the transferor and the nature of retained servicing rights. The analytical conclusion as to a “true sale” is never absolute and unconditional, but contains qualifications based on the inherent equitable powers of a bankruptcy court, as well as the unsettled state of the common law. Once the legal isolation test has been met under SFAS 140, other factors concerning the nature and extent of the transferor’s control over the transferred assets are taken into account in order to determine whether derecognition of assets is warranted, including whether the special-purpose entity (“SPE”) has complied with rules concerning qualifying special-purpose entities.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The Company is not eligible to become a debtor under the bankruptcy code. Instead, the insolvency of the Company is generally governed by the relevant provisions of the Federal Deposit Insurance Corporation (“FDIC”) Federal Deposit Insurance Act and the FDIC’s regulations. However, the “true sale” legal analysis with respect to the Company is similar to the “true sale” analysis that would be done if the Company were subject to the bankruptcy code.
 
A legal opinion regarding legal isolation for each securitization has been obtained by the Company. The “true sale” opinion provides reasonable assurance the purchased assets would not be characterized as the property of the transferring Company’s receivership or conservatorship estate in the event of insolvency and also states the transferor would not be required to substantively consolidate the assets and liabilities of the purchaser SPE with those of the transferor upon such event.
 
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 the considerations generated by the sale of the MBS issued by the securitization trust. 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 credit support to either the third-party investors or the securitization trusts. Generally, neither third-party investors nor securitization trusts have recourse to our assets or us; and neither have the ability to require us to repurchase their securities other than through enforcement of the standard representations and warranties. 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 may 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 certain criteria of SFAS 140, and are therefore not consolidated for financial reporting purposes.
 
In addition to the cash we receive from the sale of MBS, we often retain certain interests in the securitization trust. These retained interests may include subordinated classes of securities, MSRs, AAA-rated interest-only and principal-only securities, residual securities, cash reserve funds, securities associated with prepayment charges and late fees on the underlying mortgage loans, or an over collateralization account. Other than MSRs, AAA-rated interest-only and principal-only securities, and securities associated with prepayment charges and late fees on the underlying mortgage loans, these retained interests are subordinated and serve as credit enhancement for the more senior securities issued by the securitization trust. AAA-rated interest-only and principal-only securities, securities associated with prepayment charges and late fees on the underlying mortgage loans, and non-HELOC residual interests retained are included in “Securities classified as trading,” while other subordinated securities retained and HELOC residuals are included in “Securities available for sale” on the consolidated balance sheets.
 
We usually retain the servicing function for the securitized mortgage loans. As a servicer, we are entitled to receive a servicing fee equal to a specified percentage of the outstanding principal balance of the loans or a fixed dollar amount for our reverse mortgage servicing. We may also be entitled to receive additional servicing compensation, such as late payment fees or prepayment charges.
 
Transaction costs associated with the securitizations are recognized as a component of the gain or loss at the time of sale.
 
When we reclassify loans from held for investment to held for sale, we reclassify them net of the portion of the ALL that is attributable to the transferred loans, with a corresponding reduction in the ALL.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Loans Held for Investment
 
Loans are classified as held for investment (“HFI”) based on management’s intent and ability to hold the loans for the foreseeable future. Loans HFI are recorded at their unpaid principal balance, net of discounts and premiums, unamortized net deferred loan origination costs and fees and allowance for loan losses. Discounts, premiums, and net deferred loan origination costs and fees are amortized to income over the contractual life of the loan using the effective interest method.
 
Interest is recognized as revenue when earned according to the terms of the loans and when, in the opinion of management, it is collectible. Loans are evaluated for collectability and, if appropriate, interest accrual is discontinued and previously accrued interest is reversed.
 
When we have both the intention and ability to hold the loans for the foreseeable future, we reclassify loans from HFS to HFI at the lower of cost or fair value.
 
Non-Accrual Loans
 
Loans are generally placed on non-accrual status when they are 90 days past due and charged-off upon foreclosure. Large groups of smaller-balance homogeneous loans are collectively evaluated for impairment. Impairment is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, based on a loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. Specific factors used in the impaired loan identification process include, but are not limited to, delinquency status, loan-to-value ratio, the condition of the underlying collateral, credit history, and debt coverage. For impaired loans on non-accrual status, cash receipts are applied, and interest income is recognized, on a cash basis. For all other impaired loans, cash receipts are applied to principal and interest in accordance with the contractual terms of the loan and interest income is recognized on the accrual basis. Generally, a loan may be returned to accrual status when all delinquent principal and interest are brought current in accordance with the terms of the loan agreement and certain performance criteria have been met. The estimated loss upon liquidation on all other loans held for investment is charged-off prior to or upon foreclosure.
 
We account for troubled loans in accordance with FASB Statement No. 15, “Accounting by Debtor and Creditors for Troubled Debt Restructurings.” Troubled debt restructured loans are tested for impairment under FASB Statement No. 114, “Accounting by Creditors for Impairment of a Loan” (“SFAS 114”), and placed on non-accrual status. If borrowers perform pursuant to the modified loan terms for at least six months and the remaining loan balances are considered collectible, the loans are returned to accrual status.
 
Allowance for Loan Losses
 
We maintain an allowance for loan losses (the “allowance” or ALL) on loans held for investment. Additions to the allowance are based on assessments of certain factors, including but not limited to, estimated probable losses on the loans, borrower credit quality, delinquency, prior loan loss experience and general economic conditions. Additions to the allowance are provided through a charge to earnings. Specific valuation allowances may be established for loans that are deemed impaired, if default by the borrower is deemed probable, and if the fair value of the loan or the collateral is estimated to be less than the gross carrying value of the loan. Actual losses on loans are recorded as a reduction to the allowance through charge-offs. Subsequent recoveries of amounts previously charged-off are credited to the allowance.
 
For the loans held for investment portfolio, an ALL is established and allocated to various loan types. The determination of the level of the ALL and, correspondingly, the provision for loan losses, is based on delinquency trends, prior loan loss experience, and management’s judgment and assumptions regarding various matters, including general economic conditions and loan portfolio composition. Management continuously evaluates these assumptions and various relevant factors impacting credit quality and inherent losses. We utilize several


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
methodologies to estimate the adequacy of our ALL and to ensure the allocation of the ALL to the various portfolios is reasonable given current trends and economic outlook. In this regard, we segregate assets into homogeneous pools of loans and heterogeneous loans.
 
Homogeneous pools of loans exhibit similar characteristics and, as such, can be evaluated as pools of assets through the assessment of default probabilities and corresponding loss severities. Our homogeneous pools include residential mortgage loans, consumer construction loans, HELOCs, closed-end seconds, manufactured home loans and home improvement loans. The estimate of the ALL for homogeneous pools is based on recent product-specific migration patterns and recent loss experience.
 
Our builder construction loans generally carry higher balances and involve unique loan characteristics that cannot be evaluated solely through the use of default rates, loss severities and trend analysis. To estimate an appropriate level of ALL for our heterogeneous loans, we constantly screen the portfolios on an individual asset basis to classify problem credits and to estimate potential loss exposure. In this estimation, we determine the level of adversely classified assets (using the classification criteria described below) in a portfolio and the related loss potential and extrapolate the weighting of those two factors across all assets in the portfolio.
 
Our asset classification methodology was designed in accordance with guidelines established by our supervisory regulatory agencies as follows:
 
  •  Pass — Assets classified Pass are assets that are well protected by the net worth and paying capacity of the borrower or by the value of the asset or underlying collateral.
 
  •  Special Mention — Special Mention assets have potential weaknesses that require close attention, but have not yet jeopardized the timely repayment of the asset in full.
 
  •  Substandard — This is the first level of adverse classification. Assets in this category are inadequately protected by the net worth and paying capacity of the borrower or by the value of the collateral. Substandard assets are characterized by the distinct possibility some loss will occur if the deficiencies are not corrected.
 
  •  Doubtful — Assets in this category have the same weaknesses as a substandard asset, with the added characteristic that based on current facts, conditions and values, liquidation of the asset in full is highly improbable.
 
  •  Loss — Assets in the Loss category are considered uncollectible and of such little value that the continuance as an asset, without establishment of a specific valuation allowance, is not warranted.
 
A component of the overall ALL is not specifically allocated (“unallocated component”). The unallocated component reflects management’s assessment of various factors that create inherent imprecision in the methods used to determine the specific portfolio allocations. Those factors include, but are not limited to, levels of and trends in delinquencies and impaired loans, charge-offs and recoveries, volume and terms of the loans, effects of any changes in risk selection and underwriting standards, other changes in lending policies, procedures, and practices, and national and local economic trends and conditions.
 
Impaired loans include loans classified as non-accrual where it is probable we will be unable to collect the scheduled payments of principal and interest according to the contractual terms of the loan agreement. When a loan is deemed impaired, the amount of specific allowance required is measured by a complete analysis of the most probable source of repayment, including the present value of the loan’s expected future cash flows, the fair value of the underlying collateral less costs of disposition, or the loan’s estimated market value. In these measurements, we use assumptions and methodologies that are relevant to estimating the level of impaired and unrealized losses in the portfolio. To the extent the data supporting such assumptions has limitations, our judgment and experience play a key role in enhancing the ALL estimates.
 
We transferred mortgage loans HFS to HFI and recorded a reduction to the net investment, a portion of this reduction represents credit losses we estimated in determining the market value of loans. This amount represents a


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
“reserve” for future realized credit losses. If our estimate of inherent credit losses in the transferred pool increases, we may record a provision for loan losses which will increase the ALL.
 
As the housing and mortgage markets deteriorated during 2007, we made adjustments to key assumptions used to establish our loss reserves. Generally, we adjusted our assumptions as to frequency of mortgage loans moving to default and the expected severities of losses from sales of underlying REO properties. We also adjusted assumptions on our builder construction portfolio to give consideration to the project and market specific condition for loans in this portfolio that have or are expected to default.
 
Secondary Market Reserve
 
The Company maintains a secondary market reserve for losses that arise in connection with loans we are required to repurchase from GSEs and whole loan sales. This reserve has two general components: reserves for repurchases arising from representation and warranty claims, and reserves for disputes with investors and vendors with respect to contractual obligations pertaining to mortgage operations. Reserve levels are a function of expected losses based on expected and actual pending claims and repurchase requests, historical experience, loan volume and loan sales distribution channels and the assessment of probability related to such claims, and even small changes in assumptions could result in significantly higher or lower estimate. While the ultimate amount of repurchases and claims is uncertain, management believes the reserve is adequate. We will continue to evaluate the adequacy of our reserve and may continue to allocate a portion of our gain on sale proceeds to the reserve going forward. Changes in the level of provision to this reserve impacts the overall gain on sale margin from period to period. The entire balance of our secondary market reserve is included on the consolidated balance sheets as a component of “Other liabilities”.
 
Mortgage Servicing Rights
 
We retain MSRs in connection with our mortgage banking operations. Under primary servicing agreements, we collect monthly principal, interest and escrow payments from individual mortgagors and perform certain accounting and reporting functions on behalf of the mortgage investors. Under master servicing agreements, we collect monthly payments from various sub-servicers and perform certain accounting and reporting functions on behalf of the mortgage investors.
 
We recognize MSRs as separate assets only when servicing is contractually separated from the underlying mortgage loans by sale or securitization of the loans with servicing retained or by separate purchase or assumption of the servicing. MSRs are recorded at fair value with valuation changes, net of hedges, reported in “Service fee income” in the consolidated statements of operations. Because a limited and illiquid market exists for MSRs, we determine the fair value of our MSRs using discounted cash flow techniques. Using models primarily purchased from third parties, we determine the fair value of recognized MSRs by estimating the present value of anticipated future net cash flows. Estimates of fair value involve several assumptions, including the key valuation assumptions about market expectations of future prepayment rates, interest rates and discount rates, which are subject to change over time. Changes in these underlying assumptions could cause the fair value of MSRs to change significantly in the future. The Company maintains an economic hedge of its MSRs, designed primarily to mitigate the effects of changes in market interest rates, however, there could be significant fluctuations in the fair value of the MSRs in excess of the economic offset provided by the related hedging instruments. Prior to adoption of FAS 156, we carried MSRs at amortized cost subject to periodic impairment assessment. For purposes of impairment evaluation and measurement, we stratify our MSRs based on predominant risk characteristics, underlying loan type, interest rate type, and interest rate level.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Derivative Instruments
 
In seeking to protect our financial assets and liabilities from the effects of changes in market interest rates, we have devised and implemented an asset/liability management strategy that seeks, on an economic basis, to mitigate significant fluctuations in our financial position and results of operations. We invest in MSRs, AAA-rated and agency interest-only and residual securities to generate core fee and interest income. The value of these instruments and the income they provide tends to be somewhat counter-cyclical to the changes in production volumes and gain on sale of loans that result from changes in interest rates. With regard to the pipeline of mortgage loans held for sale, in general, we hedge these assets with forward commitments to sell Fannie Mae (“FNMA”) or Freddie Mac (“FHLMC”) securities with comparable maturities and weighted average interest rates. Also, we use futures or options in our pipeline hedging. To hedge our investments in MSRs, AAA-rated and agency interest-only and residual securities, we use several strategies, including buying and/or selling mortgage-backed or U.S. Treasury securities, forward rate agreements, futures, floors, interest rate swaps, or options, depending on several factors. Lastly, we enter into interest rate swap and interest rate swaption agreements to hedge the cash flows on advances or borrowings that are collateralized by our mortgage loans held for investment and MBS.
 
SFAS 133 requires that we recognize all derivative instruments on the balance sheet at fair value. If certain conditions are met, hedge accounting may be applied and the derivative instrument may be specifically designated as: (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or unrecognized firm commitment, referred to as a fair value hedge, or (b) a hedge of the exposure to the variability of cash flows of a recognized asset, liability or forecasted transaction, referred to as a cash flow hedge.
 
In the case of a qualifying fair value hedge, changes in the value of the derivative instruments that are highly effective (as defined in SFAS 133) are recognized in current earnings along with the change in value of the designated hedged item. In the case of a qualifying cash flow hedge, changes in the value of the derivative instruments that are highly effective are recognized in “Accumulated other comprehensive income (loss)” (“AOCI”) on the consolidated balance sheets, until the hedged item is recognized in earnings. The ineffective portion of a derivative’s change in fair value is recognized through earnings. Upon the occasional termination of a cash flow hedge, the remaining cost of that hedge is amortized over the remaining life of the hedged item in proportion to the change in the hedged forecasted transaction. We have derivatives in place to hedge the exposure to the variability in future cash flows for forecasted transactions through 2017. Derivatives that are non-designated hedges, as defined in SFAS 133, are adjusted to fair value through earnings. We formally document all qualifying hedge relationships, as well as our risk management objective and strategy for undertaking each hedge transaction. We are not a party to any foreign currency hedge relationships.
 
Foreclosed Assets
 
Real estate acquired in settlement of loans is initially recorded at fair value of the underlying property, less estimated costs to sell, through a charge to the allowance for loan losses, secondary market reserve or to the related valuation reserves for loans held for sale. Subsequent operating activity and declines in value are charged to earnings.
 
Goodwill and Other Intangible Assets
 
Goodwill, representing the excess of purchase price over the fair value of net assets acquired, resulted from acquisitions we have made. Core deposit intangible asset is amortized using an accelerated method of amortization over a period of ten years, which is the estimated life of the deposits acquired. Intangible assets from the acquisition of the remaining shares of Financial Freedom Senior Funding Corporation are amortized on a straight-line basis over a three-year period. Goodwill is not amortized, and we review our goodwill and other intangible assets for other-than-temporary impairment at least annually. If circumstances indicate that other-than-temporary impairment might exist, recoverability of the asset is assessed based on expected undiscounted net cash flows.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Fixed Assets
 
Fixed assets are included in other assets and are stated at cost, less accumulated depreciation and amortization. Depreciation is provided using the straight-line method in amounts sufficient to relate the cost of depreciable assets to current earnings over their estimated service lives. Estimated service lives of furniture and equipment generally range from three to seven years and 20 to 40 years for buildings. Leasehold improvements are amortized using the straight-line method over the lesser of the life of the lease or the service lives of the improvements.
 
Software Development
 
We capitalize external direct costs of materials and services consumed in developing or obtaining internal-use computer software and direct salary and benefit costs relating to the respective employees’ time spent on the software project during the application development stage. The estimated service lives for capitalized software generally range from three to seven years.
 
Income Taxes
 
Deferred income taxes in the accompanying consolidated financial statements are computed using the liability method. Under this method, deferred income taxes are provided for differences between the financial accounting and income tax basis of our assets and liabilities.
 
Share-Based Compensation
 
Our share-based compensation is provided to employees in accordance with the 2000 Stock Incentive Plan, as amended, and the 2002 Incentive Plan, as amended and restated, which allow for the grant of various types of awards (“Awards”) including, but not limited to, non-qualified stock options, incentive stock options, restricted stock awards, performance stock awards, and stock bonuses to our employees, including officers and directors. Awards are granted at the average market price of our stock on the grant date.
 
The Company adopted FASB Statement No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123(R)”), amendment of Statement No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) and Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” (“APB 25”), on January 1, 2006 using the modified-retrospective method, which requires the recognition of compensation expenses related to stock options, and revised all prior periods in accordance with SFAS 123(R) at the time of adoption. See “Note 23 — Benefit Plans” for further details on stock incentive plans.
 
The following summarizes net earnings as well as diluted earnings per share for the year ended December 31, 2005 (dollars in thousands, except per share data):
 
         
Reported net earnings
  $ 300,226  
Retrospective application of SFAS 123(R)
    7,098  
         
Adjusted net earnings
  $ 293,128  
Adjusted average diluted shares
    66,115  
Reported diluted earnings per share
  $ 4.54  
Adjusted diluted earnings per share
  $ 4.43  
 
NOTE 2 — ACQUISITIONS
 
On April 1, 2007, the Company executed its definitive agreement with New York Mortgage Trust, Inc. to purchase certain assets of the retail mortgage banking business of its wholly-owned taxable real estate investment trust (“REIT”) subsidiary, The New York Mortgage Company, LLC (“NYMC”), for a purchase price of


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
approximately $13.4 million. The Company purchased substantially all of the operating assets related to NYMC’s retail mortgage banking platform, including the use of The New York Mortgage Company name, and assumed certain liabilities of NYMC’s retail platform, including certain lease liabilities and obligations under the pipeline of loan applications. The Company hired a majority of NYMC employees and assumed a portion of the retention and severance expenses associated with the transaction.
 
On July 16, 2004, the Company acquired 93.75% of the outstanding common stock of Financial Freedom Holdings Inc. (“FFHI”) and related assets from Lehman Brothers Bank, F.S.B. and its affiliates for an aggregate cash purchase price of $84.6 million. In November 2004, FFHI merged into its wholly owned subsidiary, Financial Freedom Senior Funding Corporation (“FFSFC”) in November 2004, with FFSFC as the surviving entity. The Company owned 93.75% of the outstanding common stock of FFSFC, with the remaining 6.25% ownership held by its Chairman (FFHI and FFSFC are referred to collectively as Financial Freedom herein). The transaction was accounted for using the purchase method of accounting and resulted in $48.4 million recorded as goodwill. On July 3, 2006, the Company acquired the remaining 6.25% of the outstanding common stock of Financial Freedom from the Company’s Chairman for an aggregate cash purchase price of $40.0 million. Goodwill and other intangibles recorded from the purchase were $29.1 million and $3.8 million, respectively. As a result of this transaction, Financial Freedom became a wholly-owned subsidiary of Indymac Bank.
 
NOTE 3 — SEGMENT REPORTING
 
The Company operates through two primary segments: mortgage banking and thrift. The Company predominantly uses generally accepted accounting principles to compute each division’s financial results as if it were a stand-alone entity. Consistent with this approach, borrowed funds and their interest cost are allocated based on the funds actually used by the Company to fund the division’s assets and capital is allocated based on regulatory capital rules for the specific assets of each segment. Additionally, transactions between divisions are reflected at arms-length in these financial results and intercompany profits are eliminated in consolidation. We do not allocate fixed corporate and business unit overhead costs to our profit center divisions, because the methodologies to do so are arbitrary and distort each division’s marginal contribution to our profits. To reconcile to our consolidated results, commercial mortgage banking, mortgage banking overhead, elimination and other, and corporate overhead costs are included in the “Other” column in the table below.
 
As conditions in the U.S. mortgage market have deteriorated, we have exited certain production channels and are reporting them in a separate category in our segment reporting. These exited production channels include the conduit, homebuilder and home equity channels. These activities are not considered discontinued operations as defined by FASB Statement No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” due to our substantial continuing involvement.
 
Loans are occasionally transferred (“sold”) from the production divisions to the thrift divisions at a premium based on the estimated fair value. The premium paid for the loans is recorded as a gain in the production divisions and a premium on the asset in the thrift divisions and eliminated in consolidation. In subsequent periods, this premium is amortized as part of the thrift divisions’ net interest margin and the amortization is reversed in the “Other” column in the tables below.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The following presents segment information for the years indicated (dollars in thousands):
 
                                                         
    Mortgage Banking Segment                       Conduit,
       
    Mortgage
    Mortgage
                Total
    Home Equity,
       
    Production
    Servicing
    Thrift
          On-Going
    Homebuilder
    Total
 
    Division     Division     Segment     Other     Business     Divisions     Company  
 
Year Ended December 31, 2007
                                                       
Net interest income (expense)
  $ 132,086     $ (40,563 )   $ 234,865     $ 100,225     $ 426,613     $ 140,129     $ 566,742  
Net revenues (expense)
    245,547       382,393       (236,306 )     2,309       393,943       (390,379 )     3,564  
Net earnings (loss)
    (96,777 )     181,427       (199,247 )     (219,082 )     (333,679 )     (281,129 )     (614,808 )
Allocated average capital
    441,917       361,405       670,476       82,881       1,556,679       420,253       1,976,932  
Assets as of December 31, 2007
  $ 2,783,814     $ 3,839,975     $ 21,811,374     $ 1,242,243     $ 29,677,406     $ 3,057,062     $ 32,734,468  
Return on equity
    (22 )%     50 %     (30 )%     N/A       (21 )%     (67 )%     (31 )%
Year Ended December 31, 2006
                                                       
Net interest income (expense)
  $ 91,648     $ (11,489 )   $ 197,333     $ 67,964     $ 345,456     $ 181,265     $ 526,721  
Net revenues (expense)
    700,248       161,441       257,459       (20,954 )     1,098,194       248,509       1,346,703  
Net earnings (loss)
    227,739       66,147       112,394       (175,718 )     230,562       112,367       342,929  
Allocated average capital
    370,703       253,235       536,943       197,506       1,358,387       437,873       1,796,260  
Assets as of December 31, 2006
  $ 4,570,229     $ 2,961,833     $ 14,309,474     $ 1,005,435     $ 22,846,971     $ 6,648,345     $ 29,495,316  
Return on equity
    61 %     26 %     21 %     N/A       17 %     26 %     19 %
Year Ended December 31, 2005
                                                       
Net interest income (expense)
  $ 67,931     $ (4,022 )   $ 199,253     $ 31,464     $ 294,626     $ 130,085     $ 424,711  
Net revenues (expense)
    664,636       78,980       238,816       (32,535 )     949,897       155,813       1,105,710  
Net earnings (loss)
    242,995       27,992       108,481       (153,808 )     225,660       67,468       293,128  
Allocated average capital
    260,591       119,071       421,345       297,992       1,098,999       281,868       1,380,867  
Assets as of December 31, 2005
  $ 2,758,337     $ 1,493,680     $ 10,598,882     $ 1,389,691     $ 16,240,590     $ 5,211,709     $ 21,452,299  
Return on equity
    93 %     24 %     26 %     N/A       21 %     24 %     21 %


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
NOTE 4 — MORTGAGE-BACKED SECURITIES
 
The following presents the composition of our MBS as of the dates indicated (dollars in thousands):
 
                 
    December 31  
    2007     2006  
 
Mortgage-backed securities — trading
               
AAA-rated non-agency securities
  $ 510,371     $ 43,957  
AAA-rated and agency interest-only securities
    59,844       73,570  
AAA-rated principal-only securities
    88,024       38,478  
Prepayment penalty and late fee securities
    82,027       97,576  
Other investment grade securities
    275,691       29,015  
Other non-investment grade securities
    93,859       41,390  
Non-investment grade residual securities
    112,727       218,745  
                 
Total MBS — trading
  $ 1,222,543     $ 542,731  
                 
MBS — trading pledged as collateral for borrowings
  $ 685,869     $ 152,895  
                 
Mortgage-backed securities — available for sale
               
AAA-rated non-agency securities
  $ 5,543,306     $ 4,604,489  
AAA-rated agency securities
    45,296       65,175  
Other investment grade securities
    451,798       160,238  
Other non-investment grade securities
    61,889       38,784  
Non-investment grade residual securities
    3,687       31,828  
                 
Total MBS — available for sale
  $ 6,105,976     $ 4,900,514  
                 
MBS — available for sale pledged as collateral for borrowings
  $ 5,685,770     $ 4,149,201  
                 
Total mortgage-backed securities
  $ 7,328,519     $ 5,443,245  
                 
 
Contractual maturities of the MBS generally range from 10 to 30 years. Expected weighted average lives of these securities generally range from several months to five years due to borrower prepayments occurring prior to the contractual maturity.
 
The following summarizes the unrealized gains and losses of securities available for sale as of the dates indicated (dollars in thousands):
 
                 
    December 31  
    2007     2006  
 
Amortized cost
  $ 6,296,827     $ 4,930,825  
Gross unrealized holding gains
    13,743       13,675  
Gross unrealized holding losses
    (204,594 )     (43,986 )
                 
Estimated fair value
  $ 6,105,976     $ 4,900,514  
                 


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The following presents the unrealized losses and fair value of securities that have been in a continuous unrealized loss position for less than 12 months and 12 months or greater as of the dates indicated (dollars in thousands):
 
                                                 
    Less Than 12 Months     12 Months or Greater     Total  
    Unrealized
          Unrealized
          Unrealized
       
    Losses     Fair Value     Losses     Fair Value     Losses     Fair Value  
 
December 31, 2007
                                               
Securities — available for sale:
                                               
AAA-rated non-agency securities
  $ (74,718 )   $ 2,980,556     $ (33,446 )   $ 1,324,275     $ (108,164 )   $ 4,304,831  
AAA-rated agency securities
    (137 )     6,643       (1,233 )     11,349       (1,370 )     17,992  
Other investment grade securities
    (93,937 )     375,797       (1,123 )     21,990       (95,060 )     397,787  
                                                 
Total
  $ (168,792 )   $ 3,362,996     $ (35,802 )   $ 1,357,614     $ (204,594 )   $ 4,720,610  
                                                 
December 31, 2006
                                               
Securities — available for sale:
                                               
AAA-rated non-agency securities
  $ (1,482 )   $ 460,767     $ (39,315 )   $ 1,649,480     $ (40,797 )   $ 2,110,247  
AAA-rated agency securities
    (585 )     31,865       (172 )     16,498       (757 )     48,363  
Other investment grade securities
    (477 )     13,369       (1,891 )     25,998       (2,368 )     39,367  
Residual securities
    (64 )     4,563                   (64 )     4,563  
                                                 
Total
  $ (2,608 )   $ 510,564     $ (41,378 )   $ 1,691,976     $ (43,986 )   $ 2,202,540  
                                                 
 
As of December 31, 2007, the available for sale securities that have been in unrealized loss position for 12 months or more are primarily related to AAA-rated non-agency securities issued by private institutions. These unrealized losses are primarily attributable to changes in interest rates. Because we have the ability and the intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired at December 31, 2007.
 
As a result of our periodic reviews for impairment in accordance with Emerging Issues Task Force (“EITF”) 99-20, “Recognition of Interest Income and Impairment on Certain Investments” (“EITF 99-20”), during the years ended December 31, 2007, 2006 and 2005, we recorded $40.0 million, $10.2 million and $0.6 million, respectively, in impairment charges on investment grade, non-investment grade and residual securities.
 
We value AAA-rated interest-only securities using an option-adjusted spread (“OAS”) methodology, in which discount rates and future cash flows vary over time with the level of rates implied by each of 200 randomly-generated forward interest rate paths. When available, market information is used to validate these assumptions. The prepayment rates used to value our AAA-rated interest-only securities portfolio are based primarily on four-factor prepayment models which incorporate relative weighted average coupon (“WAC”), seasoning, burnout, and seasonality, as well as expectations of future rates implied by the forward LIBOR/swap curve. At December 31, 2007 and 2006, the weighted average constant lifetime prepayment rate assumption was 24.5% and 16.4%, respectively, and the implied yield was 12.3% and 15.4%, respectively.
 
The fair value of our residual securities is determined by discounting estimated net future cash flows, using discount rates that approximate current market rates and expected prepayment rates. Estimated net future cash flows include assumptions related to expected credit losses on these securities. We maintain a model that evaluates the


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
default rate and severity of loss on the residual securities’ collateral, considering such factors as loss experience, delinquencies, loan-to-value ratio, borrower credit scores and property type.
 
The following details the assumptions used in valuing the residual securities as of the dates indicated:
 
                                                                 
    December 31  
    2007     2006  
    Closed-End
                      Closed-End
                   
    Seconds     Subprime     Lot     HELOC     Seconds     Subprime     Lot     HELOC  
 
Weighted average discount rate
    23.1 %     24.4 %     21.8 %     21.0 %     24.6 %     20.4 %     23.5 %     20.2 %
Projected prepayment rate
    21.4 %     24.7 %     32.5 %     19.9 %     37.1 %     39.5 %     39.8 %     50.3 %
Remaining cumulative losses
    14.6 %     14.4 %     3.2 %     8.6 %     8.1 %     5.9 %     0.6 %     1.1 %
 
There were no prime residual securities as of December 31, 2007 and 2006.
 
The fair value of all of our other investment and non-investment grade mortgage-backed securities is estimated based on discounted cash flow techniques using assumptions for prepayment rates, market yield requirements and credit losses, and market information when available.
 
As of December 31, 2007, the aggregate amount of the securities from each of the following issuers was greater than 10% of consolidated shareholders’ equity (dollars in thousands):
 
                 
    Amortized
    Fair Market
 
Name of Issuer
  Cost     Value  
 
IndyMac INDX Mortgage Loan Trust 2007-AR21IP
  $ 1,592,652     $ 1,541,965  
IndyMac INDA Mortgage Loan Trust 2007-AR8
    185,933       172,264  
IndyMac INDX Mortgage Loan Trust 2006-AR19
    245,970       244,835  
Residential Asset Securitization Trust Series 2006-A4IP
    306,691       303,245  
Residential Asset Securitization Trust Series 2006-A16
    189,016       186,836  
IndyMac Certificate Trust 2004-2
    225,083       225,083  
                 
Total
  $ 2,745,345     $ 2,674,228  
                 
 
These issuers are qualifying special-purpose entities created by the Company in conjunction with the securitization transactions with the objective to recharacterize loans as securities for the following purposes: (1) lower our cost of funds; (2) improve our liquidity profile; and (3) improve our risk profile through the use of bond insurance. Of the total securities from these issuers, 95% of the securities are AAA-rated asset-backed certificates. Approximately $0.2 billion of these securities are insured by a third party.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The following sets forth certain information regarding the weighted average yields and remaining contractual maturities of our MBS portfolio as of December 31, 2007 (dollars in thousands):
 
                                                                                 
          More Than One Year
    More Than Five
             
    One Year or Less     to Five Years     Years to Ten Years     More Than Ten Years     Total  
          Wtd.
          Wtd.
          Wtd.
          Wtd.
          Wtd.
 
    Fair
    Average
    Fair
    Average
    Fair
    Average
    Fair
    Average
    Fair
    Average
 
    Value     Yield(1)     Value     Yield(1)     Value     Yield(1)     Value     Yield(1)     Value     Yield(1)  
 
AAA-rated mortgage-backed securities
                                                                               
AAA-rated agency securities
  $           $           $ 1,908       6.45 %   $ 43,388       5.87 %   $ 45,296       5.89 %
AAA-rated non-agency securities
                                        6,053,677       5.75 %     6,053,677       5.75 %
AAA-rated and agency interest-only securities
                            169       15.95 %     59,675       14.45 %     59,844       14.45 %
AAA-rated principal-only securities
                                        88,024       9.12 %     88,024       9.12 %
                                                                                 
Total AAA-rated mortgage-backed securities
                            2,077       7.22 %     6,244,764       5.88 %     6,246,841       5.88 %
Prepayment penalty and late fee securities
    2       57.28 %     1,186       15.00 %                 80,839       21.75 %     82,027       21.66 %
Other investment grade mortgage-backed securities
                3,810       8.04 %                 723,679       7.70 %     727,489       7.70 %
Other non-investment grade securities
                17,067       11.27 %                 138,681       10.95 %     155,748       10.99 %
Non-investment grade residual securities
                40,846       22.00 %                 75,568       21.71 %     116,414       21.81 %
                                                                                 
Total mortgage-backed securities
  $ 2       57.28 %   $ 62,909       18.11 %   $ 2,077       7.22 %   $ 7,263,531       6.50 %   $ 7,328,519       6.60 %
                                                                                 
 
 
(1) The weighted average yield is computed based on the amortized costs of the securities.
 
Given prepayments on the underlying collateral of our MBS, we do not expect our MBS to remain outstanding throughout their contractual maturity periods. Therefore, contractual maturity is not a relevant measure of the timing of our future expected cash flows. Actual economic cash flows are expected to be received much sooner.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
NOTE 5 — LOANS RECEIVABLE
 
The following represents a summary of loans receivable as of the dates indicated (dollars in thousands):
 
                 
    December 31,  
    2007     2006  
 
Loans held for sale
               
Principal balance of loans HFS
  $ 3,704,681     $ 9,331,112  
Unamortized premiums and fees
    46,856       176,094  
Hedge effects and other valuation adjustments
    25,367       (39,363 )
                 
Total loans held for sale
  $ 3,776,904     $ 9,467,843  
                 
Loans held for investment
               
Principal balance of mortgage loans HFI
  $ 13,522,119     $ 6,828,862  
Basis adjustment on transferred loans and unamortized premium on mortgage loans HFI
    (276,805 )     89,306  
Outstanding balance on other loans HFI(1)
    3,202,111       3,259,532  
Unamortized net deferred loan fees on other loans HFI
    6,621       (491 )
Allowance for loan losses
    (398,135 )     (62,386 )
                 
Total loans held for investment
  $ 16,055,911     $ 10,114,823  
                 
Total loans receivable
  $ 19,832,815     $ 19,582,666  
                 
Loans receivable pledged as collateral for borrowings
  $ 14,498,952     $ 14,878,632  
                 
 
 
(1) Includes consumer and builder construction loans and revolving warehouse lines of credit.
 
The Company transferred mortgage loans in the fourth quarter of 2007 with a net investment of $10.9 billion from HFS to HFI at the lower of cost or fair value as the Company no longer intended to sell these loans in the secondary market. At the time of transfer, the mortgage loans carrying value of $10.3 billion included $0.6 billion impairment loss which was recorded as a component of gain on sale of loans primarily during the third and fourth quarters of 2007.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The following presents our loans receivable by product as of the dates indicated (dollars in thousands):
 
                 
    December 31  
    2007     2006  
 
Loans held for sale
               
SFR mortgage loans
  $ 3,286,886     $ 8,801,252  
HELOCs
    168,702       633,096  
Commercial real estate loans
    320,554        
Consumer lot loans
    762       33,495  
                 
Total loans held for sale
  $ 3,776,904     $ 9,467,843  
                 
Loans held for investment
               
SFR mortgage loans
  $ 11,125,188     $ 6,519,340  
Consumer construction loans
    2,342,060       2,225,979  
Builder construction loans
    818,035       786,279  
HELOCs
    1,459,580       23,618  
Land and other mortgage loans
    660,550       375,215  
Revolving warehouse lines of credit
    48,633       246,778  
Allowance for loan losses
    (398,135 )     (62,386 )
                 
Total loans held for investment
  $ 16,055,911     $ 10,114,823  
                 
 
Our non-accrual/non-performing loans by collateral type are summarized as follows (dollars in thousands):
 
                         
    December 31  
    2007     2006     2005  
 
Homebuilder loans
  $ 480,157     $ 8,981     $  
Consumer construction loans
    77,562       25,957       9,446  
SFR mortgage loans HFI and other non-accrual/non-performing loans
    756,166       127,892       54,763  
                         
Total non-accrual/non-performing loans
  $ 1,313,885     $ 162,830     $ 64,209  
                         
 
Of the total non-accrual loans at December 31, 2007, approximately $480.2 million of impaired homebuilder loans were accounted for in accordance with SFAS 114. As of December 31, 2006 and 2005, there were no impaired loans accounted for in accordance with SFAS 114. The average balance for the SFAS 114 impaired loans during 2007 was $127.1 million. The allowance for loan losses related to these SFAS 114 impaired loans was $95.0 million at December 31, 2007. For the year ended December 31, 2007, no interest income was recognized on the SFAS 114 impaired loans subsequent to the determination of impairment. There were no significant non-accrual loans accounted for under SFAS 114 at December 31, 2006 and 2005.
 
Troubled debt restructurings, where management has granted a concession to a borrower experiencing financial difficulty, were approximately $33.1 million as of December 31, 2007. We have no significant commitments to lend additional funds to borrowers with restructured loans. There were no significant troubled debt restructuring loans at December 31, 2006 and 2005.
 
NOTE 6 — ALLOWANCE FOR LOAN LOSSES
 
Our determination of the level of the allowance for loan losses and, correspondingly, the provision for loan losses, is based on management’s judgments and assumptions regarding various matters, including general economic conditions, loan portfolio composition, loan demand, delinquency trends, and prior loan loss experience.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The allowance for loan losses of $398.1 million is considered adequate to cover probable losses inherent in the loan portfolio at December 31, 2007. However, no assurance can be given that we will not, in any particular period, sustain loan losses that exceed the allowance, or that subsequent evaluation of the loan portfolio, in light of then-prevailing factors, including economic conditions, credit quality of the assets comprising the portfolio and the ongoing examination process, will not require significant changes in the allowance for loan losses.
 
Summarized below are changes to the allowance for loan losses for the years indicated (dollars in thousands):
 
                         
    Year Ended December 31  
    2007     2006     2005  
 
Balance, beginning of year
  $ 62,386     $ 55,168     $ 52,891  
Allowance transferred to HFS loans
    (7,574 )            
Provision for loan losses
    395,548       19,993       9,978  
Charge-offs:
                       
SFR mortgage loans
    (29,186 )     (6,003 )     (2,116 )
Consumer construction loans
    (19,835 )     (3,549 )     (2,422 )
Other(1)
    (7,138 )     (5,586 )     (4,979 )
                         
Total charge-offs
    (56,159 )     (15,138 )     (9,517 )
                         
Recoveries:
                       
SFR mortgage loans
    1,200       470       639  
Consumer construction loans
    117       231       127  
Other(1)
    2,617       1,662       1,050  
                         
Total recoveries
    3,934       2,363       1,816  
                         
Total charge-offs, net of recoveries
    (52,225 )     (12,775 )     (7,701 )
                         
Balance, end of year
  $ 398,135     $ 62,386     $ 55,168  
                         
 
 
(1) Includes loans from the warehouse lines of credit, home equity lines of credit and of discontinued loan products.
 
NOTE 7 — MORTGAGE SERVICING RIGHTS
 
The following presents the assumptions used to value MSRs as of the dates indicated (dollars in thousands):
 
                         
    December 31  
    2007     2006     2005  
 
Actual
                       
Carrying Value
  $ 2,495,407     $ 1,822,455     $ 1,094,490  
Collateral Balance
    181,723,633       139,816,763       84,495,133  
Gross Weighted-Average Coupon (“WAC”)
    6.89 %     7.05 %     6.19 %
Servicing Fee
    0.34 %     0.37 %     0.37 %
3-Month Prepayment Speed
    9.7 %     20.2 %     21.7 %
Weighted-Average Multiple
    4.01       3.57       3.54  
Valuation Assumptions
                       
Projected Lifetime Prepayment Speeds (“CPR”)
    19.6 %     25.8 %     21.4 %
Discount Yield
    9.7 %     8.8 %     10.7 %


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The following presents the changes in MSRs for the years indicated (dollars in thousands):
 
                         
    Year Ended December 31  
    2007     2006     2005  
 
Balance, beginning of the year
  $ 1,822,455     $ 1,094,490     $ 640,794  
Cumulative-effect adjustment due to change in accounting for MSRs
          17,561        
Additions from loan sale or securitization
    976,482       1,075,740       701,178  
Purchase or assumption
    2,268       8,658       5,463  
Transfers to prepayment penalty and/or AAA-rated and agency interest-only securities
    (57,065 )     (4,723 )     (8,491 )
Transfers due to clean-up calls and other
    (873 )     (274 )     (3,911 )
Change in fair value due to run-off
    (408,107 )     (376,718 )      
Change in fair value due to market changes
    156,327       24,180        
Change in fair value due to application of external benchmarking policies
    3,920       (16,459 )      
Amortization
                (227,084 )
Valuation/impairment
                (13,459 )
                         
Balance, end of the year
  $ 2,495,407     $ 1,822,455     $ 1,094,490  
                         
MSRs as a percentage of the unpaid principal balance (UPB) of the underlying loans serviced (in basis points)
    137       130       130  
 
The following presents changes in the valuation allowance for impairment of MSRs for the years indicated (dollars in thousands):
 
                 
    Year Ended December 31  
    2006     2005  
 
Balance at beginning of the year
  $ (127,818 )   $ (87,997 )
Remeasurement to fair value
    127,818        
Provision for valuation
          (42,502 )
Clean-up calls exercised
          2,681  
                 
Balance at end of the year
  $     $ (127,818 )
                 
 
Upon the Company’s adoption on January 1, 2006 of FASB Statement No. 156, “Accounting for Servicing of Financial Assets, an amendment of FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, we elected to prospectively apply the fair value method for all classes of its separately recognized MSRs with changes in fair value reflected in the service fee income in the statement of operations. The difference between the fair value and the carrying amount, net of any related valuation allowance, was recorded as a cumulative-effect adjustment to retained earnings as of January 1, 2006.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
NOTE 8 — OTHER ASSETS
 
The following presents the major components of other assets as of the dates indicated (dollars in thousands):
 
                 
    December 31  
    2007     2006  
 
Investment in Federal Home Loan Bank (“FHLB”) stock, at cost
  $ 676,077     $ 762,054  
Derivative financial instruments and hedging related deposits
    404,881       349,663  
Servicing related advances
    346,125       108,835  
Interest receivable
    343,324       217,667  
Real estate owned (“REO”), net of valuation allowance of $60,939 and $6,441 at December 31, 2007 and 2006, respectively
    196,049       21,638  
Fixed assets, net of accumulated depreciation of $157,826 and $122,113 at December 31, 2007 and 2006, respectively
    136,328       181,304  
Goodwill and other intangible assets
    123,937       112,608  
Accounts receivable
    98,255       102,597  
Software development, net of accumulated amortization of $119,178 and $81,984 at December 31, 2007 and 2006, respectively
    88,308       94,509  
Other
    102,611       154,350  
                 
Total other assets
  $ 2,515,895     $ 2,105,225  
                 
 
The investment in FHLB stock consisted of capital stock, at cost, totaling $676.1 million and $762.1 million as of December 31, 2007 and 2006, respectively. Total dividend income recognized was $39.9 million, $32.1 million and $21.2 million, respectively, in 2007, 2006 and 2005. We earned a dividend yield of 5.20%, 5.37% and 4.44% in 2007, 2006 and 2005, respectively. The investment in FHLB stock is required to permit Indymac Bank to borrow from the FHLB of San Francisco.
 
Hedging related deposits represent margin deposits with our clearing agent or counterparties associated with our hedge positions. For further information on our derivative financial instruments, see “Note 14 — Derivative Instruments.”
 
In the third quarter of 2007, the Company completed the sale and leaseback of one of its properties in Pasadena, California for a purchase price of $116 million and entered into a lease agreement for a portion of the property with an initial term of ten years. The leased portion of the property serves as our mortgage banking headquarters. Accordingly, the Company removed the $54.8 million carrying value of related fixed assets from the balance sheet and recognized approximately $60 million in total gain from the sale and leaseback transaction, with approximately $24 million recognized upon sale in the third quarter of 2007 and the $36 million balance amortized over the term of the lease.
 
Depreciation and amortization expense was $77.4 million, $63.7 million and $44.1 million for the years ended December 31, 2007, 2006, and 2005, respectively.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
NOTE 9 — DEPOSITS
 
The following presents a summary of the carrying value of deposits, rates, and remaining maturities of certificates of deposit as of the dates indicated (dollars in thousands):
 
                                 
    December 31  
    2007     2006  
    Amount     Rate     Amount     Rate  
 
Non-interest-bearing checking
  $ 73,343       0.0 %   $ 72,081       0.0 %
Non-interest-bearing custodial loans servicing accounts
    725,194       0.0 %     616,904       0.0 %
Interest-bearing checking
    68,977       1.5 %     54,844       1.2 %
Savings
    2,346,534       4.5 %     1,915,333       5.0 %
                                 
Total core deposits
    3,214,048       3.3 %     2,659,162       3.6 %
                                 
Certificates of deposit, due:
                               
Within one year
    14,360,754       5.2 %     7,970,763       5.2 %
One to two years
    150,023       5.0 %     147,519       4.9 %
Two to three years
    39,626       5.0 %     56,009       4.8 %
Three to four years
    38,826       5.2 %     25,879       5.0 %
Four to five years
    11,839       5.0 %     38,475       5.2 %
Over five years
    127       5.2 %     199       5.1 %
                                 
Total certificates of deposit
    14,601,195       5.2 %     8,238,844       5.2 %
                                 
Total deposits
  $ 17,815,243       4.8 %   $ 10,898,006       4.8 %
                                 
 
The following presents interest expense by deposit type for the years indicated (dollars in thousands):
 
                         
    Year Ended December 31  
    2007     2006     2005  
 
Interest-bearing checking
  $ 784     $ 665     $ 603  
Savings
    113,520       71,385       37,561  
Certificates of deposit
    548,913       336,158       157,364  
                         
Total interest expense on deposits
  $ 663,217     $ 408,208     $ 195,528  
                         
 
At December 31, 2007, accrued interest payable was $1.6 million for interest-bearing checking, savings and certificates of deposit and is included in “Other liabilities” on the consolidated balance sheets.
 
The following summarizes certificates of deposit in amounts of $100,000 or more by remaining contractual maturity as of the dates indicated (dollars in thousands):
 
                 
    December 31  
    2007     2006  
 
Three months or less
  $ 5,250,166     $ 2,407,796  
Three to six months
    2,981,531       1,604,348  
Six to twelve months
    1,731,101       848,732  
Over twelve months
    109,476       127,884  
                 
Total certificates of deposit ($100,000 or more)
  $ 10,072,274     $ 4,988,760  
                 


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Table of Contents

 
INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
NOTE 10 — ADVANCES FROM THE FHLB
 
As a member of the FHLB, we maintain a credit line based largely on a percentage of total regulatory assets. Advances totaled $11.2 billion and $10.4 billion at December 31, 2007 and 2006, respectively, and are collateralized in the aggregate by loans, securities, all FHLB stock owned and by deposits with the FHLB. The maximum amount of credit that the FHLB will extend for purposes other than meeting withdrawals varies from time to time in accordance with its policies. The interest rates charged by the FHLB for advances typically vary depending upon maturity, the cost of funds of the FHLB, and the collateral for the borrowing.
 
The following presents the scheduled maturities of advances from the FHLB as of the dates indicated (dollars in thousands):
 
                                 
    December 31  
    2007     2006  
    Amount     Rate     Amount     Rate  
 
Within one year
  $ 3,584,000       4.9 %   $ 5,053,000       5.2 %
One to two years
    2,757,000       4.8 %     1,151,000       4.8 %
Two to three years
    1,479,000       4.8 %     1,491,000       4.9 %
Three to four years
    1,789,800       5.2 %     759,000       4.8 %
Four to five years
    805,000       5.1 %     1,789,800       5.2 %
Over five years
    774,000       5.0 %     169,000       5.0 %
                                 
Total
  $ 11,188,800       4.9 %   $ 10,412,800       5.1 %
                                 
 
The following presents financial data pertaining to advances from the FHLB as of or for the dates indicated (dollars in thousands):
 
                 
    As of or For the Year Ended December 31  
    2007     2006  
 
Weighted average coupon rate, end of year
    4.9 %     5.1 %
Weighted average rate during the year, including hedge effect
    5.2 %     4.7 %
Average balance of advances from FHLB during the year
  $ 13,531,225     $ 10,560,896  
Maximum amount of advances from FHLB at any month-end
  $ 14,546,800     $ 12,688,800  
Interest expense for the year
  $ 701,226     $ 491,300  
Amount of advances subject to call/put options
  $ 899,000     $ 309,000  
 
We had $5.5 billion and $5.2 billion of unused committed financing from the FHLB at December 31, 2007 and 2006, respectively.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
NOTE 11 — OTHER BORROWINGS
 
The following presents other borrowings of the Company as of the dates indicated (dollars in thousands):
 
                 
    December 31  
    2007     2006  
 
Trust preferred debentures
  $ 441,285     $ 456,695  
HELOC notes payable
    212,747       659,283  
Asset-backed commercial paper
          2,115,839  
Loans and securities sold under agreements to repurchase
          1,407,199  
Other notes payable
          1,009  
Others(1)
    (1,254 )     (3,025 )
                 
Total other borrowings
  $ 652,778     $ 4,637,000  
                 
 
 
(1) This represents the unamortized portion of the facility issue cost and commitment fee.
 
At December 31, 2007, we had $4.8 billion in committed financing whole loan financing facilities. Of these committed financing facilities, $1.0 billion was available for use based on eligible collateral. Decisions by our lenders and investors to make additional funds available to us in the future will depend upon a number of factors. These include our compliance with the terms of existing credit arrangements, our financial performance, eligible collateral, changes in our credit rating, industry and market trends in our various businesses, the general availability and interest rates applicable to financing and investments, the lenders’ and/or investors’ own resources and policies concerning loans and investments and the relative attractiveness of alternative investment or lending opportunities.
 
Asset-Backed Commercial Paper
 
In April 2006, we established the North Lake Capital Funding Program, a single seller asset-backed commercial paper (“ABCP”) facility, which allows us to directly issue secured liquidity notes backed by mortgage loans. Both the collateral pledged and secured liquidity notes are recorded on our balance sheet as assets and liabilities, respectively. The secured liquidity notes have been rated F-1+ by Fitch Ratings, P-1 by Moody’s Investors Service and A-1+ by Standard & Poor’s, and are supported by credit enhancements, such as over collateralization, excess spread, and market value interest rate swaps provided by highly rated counterparties. We are authorized to issue up to $4.0 billion in short-term notes, with expected maturities not to exceed 180 days after issuance and final maturities of 60 days following the expected maturities. As of December 31, 2007, we did not have any secured liquidity notes outstanding. As a result of the disruption in the extendible ABCP market, we actively paid down this facility during the third quarter of 2007. Additionally, the viability of the extendible ABCP market and this facility is unknown and therefore, at this time, we are not relying on this facility for future funding needs. As of February 2008, we are in the process of terminating this facility.
 
In November 2006, we established a multi-seller ABCP facility (which is supported by backstop liquidity facilities from highly rated banks) to provide up to $1.5 billion dedicated financing for our construction to permanent, lot, and reverse mortgage loans. This is an annually renewable 364-day committed facility administered by Citicorp North America, Inc. This facility was terminated effective November 2007.
 
Loans and Securities Sold Under Agreements to Repurchase
 
We had no repurchase agreement borrowings at December 31, 2007 as a result of our strategy to increase our deposits and advances from the FHLB. The amount outstanding under loans and securities sold under agreements to repurchase was $1.4 billion at December 31, 2006. Our outstanding repurchase agreements have an average maturity of less than 30 days. These repurchase agreements generally reprice on an overnight-to-one-month basis


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
for loans, and a one-to-three-month basis for securities, bearing interest at rates indexed to LIBOR or the federal funds rate, plus an applicable margin. We were in compliance with all material financial covenants under these repurchase agreements at December 31, 2007 and 2006. For the years ended December 31, 2007 and 2006, the weighted average borrowing rate on repurchase agreements, including the multi-seller ABCP facility, was 5.8% and 5.2%, respectively.
 
The following presents additional information related to our repurchase agreements (including the ABCP facility) as of or for the years indicated (dollars in thousands):
 
                         
    As of or For the Year Ended December 31  
    2007     2006     2005  
 
Average balance during the year
  $ 2,088,580     $ 3,726,067     $ 2,947,552  
Maximum balance outstanding at any month-end(1)
    3,601,049       6,026,510       5,254,136  
Balance at December 31
          2,455,505       3,057,262  
Weighted average interest rate, end of year
          5.5 %     4.7 %
Weighted average coupon rate during the year
    5.8 %     5.2 %     3.9 %
 
 
(1) The maximum amount of borrowings outstanding occurred in February 2007, February 2006, and August 2005.
 
Trust Preferred Securities and Warrants
 
On November 14, 2001, we completed an offering of Warrants and Income Redeemable Equity Securities (“WIRES”) to investors. Gross proceeds of the transaction were $175 million. The securities were offered as units consisting of trust preferred securities, issued by a trust formed by us, and warrants to purchase IndyMac Bancorp’s common stock. As part of this transaction, IndyMac Bancorp issued subordinated debentures to the trust and purchased common securities from the trust. The yield on the subordinated debentures and the common securities is the same as the yield on the trust preferred securities. Also, we issued 3,500,000 warrants, each convertible into 1.5972 shares of IndyMac Bancorp’s common stock as part of the WIRES offering. Beginning on November 14, 2006, Indymac has the option to redeem the warrants for cash equal to the warrant value subject to the conditions in the prospectus. During 2007, a total of 40,000 warrants were exercised at an exercise price of $35.17 per share to purchase 63,888 shares of IndyMac Bancorp’s common stock. During 2006, a total of 2.5 million warrants were exercised at an average exercise price of $35.09 per share to purchase 4.0 million shares of IndyMac Bancorp’s common stock. To date, total warrants of 2.6 million have been exercised and converted into a total of 4.2 million shares of IndyMac Bancorp’s common stock. Subordinated debentures redeemed in conjunction with the warrant exercises totaled $130.2 million and $64.5 million as of December 31, 2007 and 2006, respectively.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
In 2007, we issued an additional $30 million in pooled trust preferred securities. To date, we have issued $398 million trust preferred securities (without warrants attached). The following summarizes the trust preferred securities by issuance at December 31, 2007 (dollars in thousands):
 
                         
    Face Amount     Interest Rate    
Maturity Date
 
June 2007
  $ 30,000       6.80 %     June 2037  
December 2006
    20,000       6.74 %     January 2037  
December 2006
    40,000       6.90 %     March 2037  
September 2006
    38,000       6.96 %     December 2036  
June 2006
    90,000       7.35 %     September 2036  
December 2005
    90,000       6.31 %     December 2035  
December 2004
    30,000       5.83 %     March 2035  
December 2003
    30,000       6.30 %     January 2034  
July 2003
    30,000       6.05 %     July 2033  
                     
Total
  $ 398,000                  
                     
 
Interest rates on these securities are fixed for terms ranging from 5 to 10 years, after which the rates reset quarterly indexed to 3-month LIBOR. The securities can be called at the option of IndyMac Bancorp five or ten years after issuance. In each of these transactions, IndyMac Bancorp issued subordinated debentures to, and purchased common securities from, each of the trusts. The rates on the subordinated debentures and the common securities in each of these transactions matches the rates on the related trust preferred securities. The proceeds of these securities have been used in ongoing operations.
 
Recorded values of the subordinated debentures underlying the trust preferred securities, which represent the liabilities due from IndyMac Bancorp to the trusts, totaled $441.3 million and $456.7 million at December 31, 2007 and 2006, respectively. These subordinated debentures are included in “Other borrowings” on the consolidated balance sheets.
 
Revolving Syndicated Bank Credit Facilities
 
In June 2005, a revolving unsecured syndicated bank facility in the aggregate amount of $75 million was executed between IndyMac Bancorp and Wells Fargo Bank, N.A., which was later increased to $100 million in June 2006. The interest rate is based on LIBOR plus an applicable margin. We did not draw on the line during 2007 and 2006 and this facility was terminated in November 2007.
 
Other Notes Payable
 
The Company participates in certain real estate construction projects through the builder construction division. The special purpose entities formed related to these real estate projects have been evaluated and determined to be VIEs under the definition of FIN 46R and we are deemed as the primary beneficiary of the VIEs, and thus, required to consolidate the VIEs. At December 31, 2007, there was no notes payable in the VIEs.
 
Commitment Fees
 
At December 31, 2007 and 2006, we had deferred commitment fees totaling $1.3 million and $3.0 million, respectively. Amortization of $4.7 million and $4.4 million was recognized as interest expense in 2007 and 2006, respectively. We amortize these fees over the contractual life of the borrowings.


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Table of Contents

 
INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Pledged Assets for Borrowings
 
We pledged certain of our loans and securities for our borrowings, which mainly consist of advances from FHLB and loans and securities sold under agreements to repurchase. The following provides information related to such pledged assets as of the dates indicated (dollars in millions):
 
                 
    December 31  
    2007     2006  
 
Loans pledged for FHLB advances
  $ 11,896     $ 8,747  
Securities pledged for FHLB advances
    6,372       3,598  
Loans pledged for repurchase agreements
    1,347       4,058  
Securities pledged for repurchase agreements
          704  
Loans pledged for other
    1,256       2,074  
                 
Total pledged loans and securities
  $ 20,871     $ 19,181  
                 
 
As of December 31, 2007, pledged assets exceeded our borrowings. The excess collateral was held by a trustee and pledged to our lenders.
 
The following details the amounts allocated among the various lenders as of the dates indicated (dollars in millions):
 
                 
    December 31  
    2007     2006  
 
FHLB
  $ 7,079     $ 1,932  
Federal Reserve
    1,256       662  
Dresdner
    867        
Morgan Stanley
    480       126  
Merrill Lynch
          1,001  
UBS Warburg
          513  
Greenwich
          378  
Citicorp
          266  
North Lake Capital Funding
          350  
Other
          21  
                 
Total excess
  $ 9,682     $ 5,249  
                 
 
Debt Covenants
 
The Company is subject to various debt covenants as a condition of its borrowing facilities. As of December 31, 2007, in addition to the standard covenants of timely repayments of interest and principal, the key debt covenants include maintaining minimum well-capitalized capital ratios (5%, 6%, and 10% for Tier 1 (core) capital, Tier 1 risk-based capital and total risk-based capital, respectively) and minimum net worth of $1 billion for the Company. As of December 31, 2007, we believe we were in compliance with all material financial covenants under our borrowing facilities.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The following summarizes our sources of financing as of December 31, 2007 (dollars in millions):
 
                                 
    Committed
    Outstanding
         
Financial Institution or Instrument
  Financing     Balances    
Type of Financing
 
Maturity Date
 
North Lake Capital Funding
  $ 4,000     $       Asset-Backed Commercial Paper       April 2010  
Morgan Stanley
                Whole Loan Repurchase Agreement       (1)  
Dresdner
    750             Whole Loan Repurchase Agreement       May 2008  
                         
Total
    4,750                        
Advances from FHLB
    16,732       11,189                  
HELOC Note Trust (2004-2)
    213       213       Note Trust       October 2036  
                         
Sub-total financing
    21,695       11,402                  
Deposits
          17,815                  
Trust Preferred Debentures
          441       Trust Preferred Debentures       November 2031 – June 2037  
                         
Total Financing
  $ 21,695     $ 29,658                  
                         
 
 
(1) This facility was terminated effective December 31, 2007.
 
NOTE 12 — PARENT COMPANY FINANCIAL STATEMENTS
 
The following presents condensed financial statements of the Parent Company, IndyMac Bancorp, as of and for the years indicated (dollars in thousands):
 
Condensed Balance Sheets
 
                 
    December 31  
    2007     2006  
 
Assets
               
Cash
  $ 63,952     $ 153,839  
Securities classified as trading
    1,224       1,556  
Securities classified as available for sale
    502       57,037  
Loans held for investment, net
    283       922  
Investment in and advances to subsidiaries
    1,711,582       2,304,573  
Investment in non-consolidated subsidiaries
    17,069       16,960  
Other assets
    29,375       22,580  
                 
Total assets
  $ 1,823,987     $ 2,557,467  
                 
                 
Liabilities and Shareholders’ Equity
               
Trust preferred debentures
  $ 441,459     $ 458,218  
Loans and securities sold under agreements to repurchase
          55,034  
Other liabilities
    15,175       14,821  
Shareholders’ equity
    1,367,353       2,029,394  
                 
Total liabilities and shareholders’ equity
  $ 1,823,987     $ 2,557,467  
                 


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Condensed Statements of Operations
 
                         
    Year Ended December 31  
    2007     2006     2005  
 
Interest income
                       
Securities available for sale and trading
  $ 1,423     $ 5,357     $ 7,836  
Loans
    120       196       328  
Other
    6,529       5,074       2,611  
                         
Total interest income
    8,072       10,627       10,775  
                         
Interest expense
                       
Trust preferred debentures
    31,927       26,652       17,182  
Other
    2,210       3,483       4,032  
                         
Total interest expense
    34,137       30,135       21,214  
                         
Net interest expense
    (26,065 )     (19,508 )     (10,439 )
Provision for loan losses
          25       (500 )
                         
Net interest expense after provision for loan losses
    (26,065 )     (19,533 )     (9,939 )
Non-interest income (loss)
                       
Equity in earnings (loss) of subsidiaries
    (570,050 )     360,393       304,601  
Net gain (loss) on securities
    (2,066 )     3,591       4,299  
Other income, net
    2       85       53  
                         
Total non-interest income (loss)
    (572,114 )     364,069       308,953  
                         
Net revenues (loss)
    (598,179 )     344,536       299,014  
Non-interest expense
    9,859       13,461       17,376  
                         
Earnings (loss) before provision (benefit) for income taxes
    (608,038 )     331,075       281,638  
Provision (benefit) for income taxes
    (14,379 )     (11,100 )     (8,867 )
                         
Net earnings (loss)
  $ (593,659 )   $ 342,175     $ 290,505  
                         


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Condensed Statements of Cash Flows
 
                         
    Year Ended December 31  
    2007     2006     2005  
 
Cash flows from operating activities:
                       
Net (loss) earnings
  $ (593,659 )   $ 342,175     $ 290,505  
Adjustments to reconcile net (loss) earnings to net cash (used in) provided by operating activities:
                       
Depreciation and net amortization (accretion)
    2,545       608       (1,869 )
Compensation expenses related to stock options and restricted stock
    2,827       3,275       10,067  
Loss (gain) on mortgage-backed securities, net
    2,066       (3,591 )     (4,299 )
Provision for loan losses
          25       (500 )
Loss (equity) in earnings of subsidiaries
    570,050       (360,393 )     (304,601 )
Payments from trading securities
    253       7,703       19,332  
Net (increase) decrease in other assets and liabilities
    (2,062 )     (9,440 )     7,646  
                         
Net cash (used in) provided by operating activities
    (17,980 )     (19,638 )     16,281  
                         
Cash flows from investing activities:
                       
Net decrease in loans held for investment
    634       1,059       1,809  
Net purchases of securities available for sale
          (22,207 )     (21,196 )
Proceeds from sale of and net payments from available for sale securities
    55,629       39,474       41,304  
Cash dividends from Indymac Bank
    186,244       178,132       146,212  
Decrease in investment in and advances to subsidiaries, net of cash payments
    607       7,228       5,102  
Capital contributions to Indymac Bank and other subsidiaries
    (260,000 )     (354,127 )     (247,265 )
Net sale (purchases) of property, plant and equipment
    (11 )     2,552       (25 )
                         
Net cash used in investing activities
    (16,897 )     (147,889 )     (74,059 )
                         
Cash flows from financing activities:
                       
Proceeds from issuance of trust preferred debentures
    30,000       188,000       90,000  
Redemption of trust preferred securities
    (48,268 )     (47,271 )      
Net decrease in borrowings
    (55,545 )     (14,461 )     (17,118 )
Net proceeds from issuance of common stock
    145,588       148,470        
Net proceeds from stock options, warrants, and notes receivable
    4,340       110,527       46,590  
Cash dividends paid
    (129,568 )     (129,535 )     (98,501 )
Purchases of common stock
    (1,557 )     (2,061 )     (582 )
                         
Net cash (used in) provided by financing activities
    (55,010 )     253,669       20,389  
                         
Net (decrease) increase in cash and cash equivalents
    (89,887 )     86,142       (37,389 )
Cash and cash equivalents at beginning of year
    153,839       67,697       105,086  
                         
Cash and cash equivalents at end of year
  $ 63,952     $ 153,839     $ 67,697  
                         


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Table of Contents

 
INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
NOTE 13 — TRANSFERS AND SERVICING OF FINANCIAL ASSETS
 
Retained Assets
 
In conjunction with the sale of mortgage loans in private-label securitizations and GSE transactions, the Company generally retains certain assets. The primary assets retained include MSRs, AAA-rated agency and non-agency securities, and to a lesser degree, AAA-rated interest-only and principal-only securities, prepayment penalty and late fee securities, other investment grade securities, non-investment grade securities, and residual securities. The allocated cost of the retained assets at the time of sale is recorded as an asset with an offsetting increase to the gain on sale of loans (or a reduction in the cost basis of the loans sold).
 
The key assumptions used in measuring the fair value of retained assets at the time of sale during the year ended December 31, 2007 on a weighted average basis were as follows (dollars in thousands):
 
                                 
                      Projected
 
    Retained
    Lifetime
    Discount
    Loss
 
    Balance     CPR     Yield     Rate  
 
MSRs
  $ 988,198       22.11 %     7.72 %     N/A  
AAA-rated agency and non-agency securities
    2,006,563       22.51 %     5.86 %     N/A  
AAA-rated interest-only securities
    6,044       27.01 %     17.64 %     N/A  
AAA-rated principal-only securities
    8,158       10.34 %     6.84 %     N/A  
Prepayment penalty and late fee securities
    47,555       22.62 %     12.64 %     N/A  
Other Investment grade mortgage-backed securities
    519,613       24.68 %     7.11 %     N/A  
Non-investment grade mortgage-backed securities
    128,896       20.13 %     15.68 %     2.00 %
Non-investment grade residual securities
    40,179       31.31 %     22.17 %     4.93 %
                                 
Total
  $ 3,745,206                          
                                 
 
The following shows the hypothetical effect on the fair value of our retained assets using various unfavorable variations of the expected levels of certain key assumptions used in valuing these assets at December 31, 2007 (dollars in thousands):
 
                                                                         
                                  Other
    Non-
             
                                  Investment
    Investment
             
          AAA-rated
          AAA-Rated
    Prepayment
    Grade
    Grade
             
    Mortgage
    Agency and
    AAA-Rated
    Principal-
    Penalty
    Mortgage-
    Mortgage-
             
    Servicing
    Non-Agency
    Interest-Only
    Only
    and Late Fee
    Backed
    Backed
    Residual
       
    Rights     Securities     Securities     Securities     Securities     Securities     Securities     Securities     Total  
 
Balance sheet carrying value of retained interests
  $ 2,495,407     $ 6,098,973     $ 59,844     $ 88,024     $ 82,027     $ 727,489     $ 155,748     $ 116,414     $ 9,823,926  
                                                                         
Prepayment speed assumption
    19.60 %     22.40 %     24.50 %     17.48 %     22.14 %     21.70 %     25.10 %     23.30 %     N/A  
Impact on fair value of 10% adverse change of prepayment speed
  $ 152,956     $ (74,269 )   $ 5,740     $ (2,672 )   $ (2,924 )   $ (1,477 )   $ 1,802     $ 12,573     $ 91,729  
Impact on fair value of 20% adverse change of prepayment speed
  $ 288,464     $ (9,430 )   $ 10,679     $ (5,048 )   $ (6,180 )   $ (2,804 )   $ 2,733     $ 23,134     $ 301,548  
Discount rate assumption
    9.70 %     6.30 %     12.30 %     8.45 %     15.27 %     11.20 %     31.20 %     22.20 %     N/A  
Impact on fair value of 100 basis point adverse change
  $ 90,712     $ 145,912     $ 3,089     $ 2,843     $ 1,376     $ 35,390     $ 5,661     $ 4,637     $ 289,620  
Impact on fair value of 200 basis point adverse change
  $ 174,540     $ 286,511     $ 6,099     $ 5,488     $ 2,664     $ 59,189     $ 10,966     $ 8,865     $ 554,322  
Net credit loss assumption
    N/A       N/A       N/A       N/A       N/A       N/A       5.00 %     8.60 %     N/A  
Impact on fair value of 10% adverse change in credit losses
    N/A       N/A       N/A       N/A       N/A       N/A     $ 13,810     $ 20,782     $ 34,592  
Impact on fair value of 20% adverse change in credit losses
    N/A       N/A       N/A       N/A       N/A       N/A     $ 22,712     $ 36,490     $ 59,202  


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The adverse change of prepayment speed is assumed as an increase in prepayment speed as MSRs represent our second largest retained assets at December 31, 2007 and most sensitive to changes in prepayment speeds. The negative amounts in the table indicate increases in value resulting from changes in prepayment speed, which partially offset the declines in value of other retained assets.
 
These sensitivities are hypothetical and should be used with caution. Changes in fair value based on a ten percent variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. The effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumption, or considering the offsetting hedging impacts. In reality, changes in one factor may result in changes in another, such as hedging strategies and associated gains or losses, which might magnify or counteract the sensitivities.
 
Credit Risk on Securitizations
 
With regard to the issuance of private-label securitizations, we generally retain limited credit exposure in that we retain certain non-investment grade securities and residual securities. These securities are subordinate to investors’ investment-grade securities. We do not have credit exposure associated with non-performing loans in securitizations beyond our investment in retained interests in non-investment grade securities and residual securities. The value of our retained interests include credit loss assumptions on the underlying collateral pool to estimate this risk.
 
The following summarizes the collateral balance associated with our servicing portfolio of sold loans, and the balance of non-investment grade securities and residual securities retained at December 31, 2007 (dollars in thousands):
 
                         
          Balance of Retained Assets
 
          with Credit Exposure  
    Total Loans
    Non-Investment
    Residual
 
    Serviced     Grade Securities     Securities  
 
Prime
                       
Indymac securitizations
  $ 76,319,778     $ 112,703     $ 84,422  
GSEs
    70,119,928              
Whole loan sales
    29,676,055              
Subprime
                       
Indymac securitizations
    4,881,209       43,044       31,993  
GSEs
    452,466              
Whole loan sales
    186,543              
Manufactured housing securitization
    87,654              
                         
Total
  $ 181,723,633     $ 155,747     $ 116,415  
                         
 
As part of the normal course of business involving loans sold to the secondary market, we can be required to repurchase loans or make certain payments to settle breaches of our standard representations and warranties made as part of the loan sales or securitizations. In anticipation of future expected losses related to these loans, we have established secondary market reserves and have recorded provisions of $232.5 million, $37.3 million, and $19.6 million to this reserve as reductions to our gain on sale of loans during 2007, 2006, and 2005, respectively. The balance in this reserve was $179.8 million and $33.9 million at December 31, 2007 and 2006, respectively, which is included on the consolidated balance sheets as a component of “Other liabilities”. The calculation of the reserve is a function of estimated losses based on expected and actual pending claims and repurchase requests, historical experience, loan volume and loan sale distribution channels, and even small changes in assumptions could result in a significantly higher or lower estimate.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Qualifying Special-Purpose Entities
 
All loans sold in our private-label securitizations are issued through securitization trusts, which are “qualifying special-purpose entities” (“QSPEs”) under SFAS 140. The following presents cash flows received from and paid to securitization trusts for the years indicated (dollars in thousands):
 
                         
    Year Ended December 31  
    2007     2006     2005  
 
Proceeds from new securitizations
  $ 21,382,056     $ 29,557,068     $ 31,018,699  
Servicing fees received
    103,554       89,993       63,720  
Other cash flows received on retained interests
    491,575       340,843       240,703  
Clean-up calls
          (31,483 )     (141,487 )
Loan repurchases for representations and warranties
    (36,562 )     (19,632 )     (8,400 )
 
As part of our normal servicing operations, the Company advanced cash to investors totaling $1.2 billion and $195.3 million during the years ended December 31, 2007 and 2006, respectively, and received cash reimbursements from investors totaling $1.1 billion and $171.1 million, respectively.
 
From time to time, Indymac creates net interest margin (“NIM”) trusts for the securitization of residual securities and securities associated with prepayment charges on the underlying mortgage loans from prior or recently completed securitization transactions. NIM trusts issue notes to outside investors secured by the residual securities and securities associated with prepayment charges on the underlying mortgage loans we contribute to the trusts. The cash proceeds from the sale of the NIM notes to investors are paid to us as payment for the securities. The NIM notes are obligations of the NIM trusts and are collateralized only by the residual securities and securities associated with prepayment charges on the underlying mortgage loans. We are not obligated to make any payments on the notes. These entities represent QSPEs and meet the legal isolation criteria of SFAS 140. Therefore, these entities are not consolidated for financial reporting purposes in accordance with SFAS 140. At inception, the outside investors have the majority interest in the fair value of the residual securities and securities associated with prepayment charges on the underlying mortgage loans. We receive cash flows from our retained interests in the NIM trusts once the notes issued to the investors are fully paid off. We created one NIM trust during 2007 and three NIM trusts during 2006. At December 31, 2007 and 2006, our retained interests in these NIM trusts were valued at $1.3 million and $89.1 million, respectively. Our retained interests in the NIM trusts are included as a component of “Securities classified as trading” in the consolidated balance sheets.
 
NOTE 14 — DERIVATIVE INSTRUMENTS
 
We follow the provisions of SFAS 133, as amended, for our derivative instruments and hedging activities, which require us to recognize all derivative instruments on the consolidated balance sheets at fair value. FNMA and FHLMC forward contracts, forward rate agreements, interest rate swap agreements, interest rate swaption agreements, interest rate floor agreements, interest rate cap agreements, Eurodollar futures, and rate lock commitments were identified as derivative financial instruments and recorded at fair value as of December 31, 2007 and 2006.
 
Generally speaking, if interest rates increase, the value of our rate lock commitments and funded loans decrease and loan sale margins are adversely impacted. We economically hedge the risk of overall changes in fair value of loans held for sale and rate lock commitments generally by selling forward contracts on securities of GSEs and by using futures and options. Under SFAS 133, certain of these positions qualify as a fair value hedge of a portion of the funded loan portfolio and result in adjustments to the carrying value of designated loans through gain on sale based on value changes attributable to the hedged risk. The forward contracts used to economically hedge the loan commitments are accounted for as non-designated hedges and naturally offset loan commitment mark-to-market gains and losses recognized as a component of gain on sale. The loan commitments are initially valued at zero, and the Company records only the change in the fair value of the loan commitments. The initial value inherent


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
in the loan commitments at origination is recorded as a component of gain on sale of loans when the underlying loan is sold. At December 31, 2007 and 2006, the fair value of these commitments amounted to $7.7 million and $(9.8) million, respectively.
 
We use interest rate swaps, interest rate swaption agreements and interest rate caps to reduce our exposure to interest rate risk inherent in a portion of the current and anticipated borrowings and advances. An interest rate swap agreement is a contract between two parties to exchange cash flows based on specified underlying notional amounts and indices. An interest rate swaption agreement is an option to enter into an interest rate swap agreement in the future. An interest rate cap is a derivative that protects the holder from rates rising above the agreed strike price. The holder receives money at the end of each period in which the interest rate exceeds the agreed strike price. Under SFAS 133, the interest rate swaps, interest rate swaption agreements and caps used to hedge our anticipated borrowings and advances qualify as cash flow hedges. As of December 31, 2007, our interest rate swaps and caps carried deferred losses of $16.8 million, while our interest rate swaption agreements carried deferred losses of $18.9 million. The net deferred loss of $21.7 million (net of tax) was recorded as a component of AOCI. Future effective changes in fair value on these interest rate swap, interest rate swaption agreements and interest rate caps will be adjusted through AOCI as long as the cash flow hedge requirements continue to be met. AOCI contains approximately $4.7 million (net of tax) in deferred cash flow hedge gains and $6.4 million (net of tax) in deferred cash flow hedge losses that the Company expects to be realized into income over the next 12 months, based on the respective December 31, 2007 valuations. At December 31, 2006, our interest rate swaps, interest rate swaptions and caps carried a net deferred valuation loss of $6.8 million (net of tax), which was recorded as a component of AOCI.
 
We use instruments including Eurodollar futures, forward rate agreements, interest rate caps, interest rate swaps and interest rate swaptions to economically hedge our MSR asset, thereby mitigating valuation declines that result from changes and volatility in the interest rate environment. Gains and losses on these derivative financial instruments are classified as a component of “Service fee income” for mortgage servicing rights, and as a component of “Gain (loss) on mortgage-backed securities”, for our AAA-rated and agency interest-only, principal-only securities, and residual securities.
 
Indymac recognizes ineffective changes in hedge values resulting from designated SFAS 133 hedges discussed above in the same income statement captions as effective changes when such ineffectiveness occurs. Indymac recognized gains (losses) totaling $6.2 million, $(3.0) million, and $(1.2) million of ineffectiveness in earnings for the years ended December 31, 2007, 2006, and 2005, respectively.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The following presents derivative financial instruments as of the dates indicated (dollars in thousands):
 
                         
    Notional
          Expiration
 
    Amounts     Fair Value     Dates  
 
December 31, 2007
                       
Loans held for sale/loans held for investment hedges:
                       
Rate lock commitments
  $ 4,840,998     $ 7,713       2008  
Forward agency and loan sales
    3,737,149       (21,908 )     2008  
Eurodollar futures contracts
    14,856,000       (24,950 )     2012  
Mortgage servicing and other servicing-related assets hedges:
                       
Interest rate caps (LIBOR/Swaps)
    146,474       1,737       2008-2012  
Forward agency and loan sales
    12,152,000       73,880       2008  
Forward rate agreements
    2,000,000       (2,780 )     2008  
Eurodollar futures contracts
    20,150,000       (8,096 )     2008-2010  
Swap spreadlocks
    500,000       (2,590 )     2008  
Interest rate swaps (LIBOR)
    28,212,310       (28,408 )     2008-2037  
Interest rate swaptions (LIBOR)
    13,745,000       472,281       2008-2018  
Other MBS hedges:
                       
Forward agency and loan sales
    (80,000 )     (681 )     2008  
Interest rate swaps (LIBOR)
    1,340,000       (22,238 )     2009-2018  
Interest rate swaptions (LIBOR)
    790,000       12,821       2008-2009  
Eurodollar futures contracts
    4,200,000       (5,660 )     2008-2012  
Borrowings and advances hedges:
                       
Interest rate swaps (LIBOR)
    300,000       (18,646 )     2014-2017  
Interest rate swaptions (LIBOR)
    295,000       520       2008-2009  
                         
    $ 107,184,931     $ 432,995          
                         
December 31, 2006
                       
Loans held for sale hedges:
                       
Rate lock commitments
  $ 8,181,111     $ (9,751 )     2007  
Forward agency and loan sales
    5,076,325       4,562       2007  
Eurodollar futures contracts
    25,524,000       7,813       2007-2011  
Mortgage servicing and other servicing-related assets hedges:
                       
Interest rate caps (LIBOR/Swaps)
    454,218       2,918       2007-2011  
Forward agency and loan sales
    1,115,000       (4,938 )     2007  
Forward rate agreements
    26,000,000       8,355       2007  
Eurodollar futures contracts
    16,455,000       2,460       2007-2010  
Interest rate swaps (LIBOR)
    16,105,316       17,453       2007-2036  
Interest rate swaptions (LIBOR)
    4,780,000       165,212       2007-2011  
Borrowings and advances hedges:
                       
Interest rate caps (LIBOR/Swaps)
    40,822       218       2007  
Interest rate swaps (LIBOR)
    1,943,476       21,054       2007-2016  
Interest rate swaptions (LIBOR)
    745,000       3,623       2007-2009  
                         
    $ 106,420,268     $ 218,979          
                         


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
While we do not anticipate nonperformance by the counterparties, we manage credit risk with respect to such financial instruments by entering into agreements with entities (including their subsidiaries) approved by a committee of the Board of Directors and with a long term credit rating of “A” or better. For certain counterparties, we do receive margin deposits (cash collateral) to support the financial instruments with these approved entities.
 
NOTE 15 — FAIR VALUE OF FINANCIAL INSTRUMENTS
 
Fair value estimates were determined for existing balance sheet and off-balance sheet financial instruments, including derivative instruments, without attempting to estimate the value of certain assets and liabilities that are not considered financial instruments. Significant assets that are not considered financial instruments under FASB Statement No. 107, “Disclosures about Fair Value of Financial Instruments,” include MSRs, foreclosed assets, fixed assets, goodwill and intangible assets.
 
The estimated fair value amounts of our financial instruments have been determined using available market information and valuation methods we believe are appropriate under the circumstances. These estimates are inherently subjective in nature and involve matters of significant uncertainty and judgment to interpret relevant market and other data. The use of different market assumptions and/or estimation methods may have a material effect on the estimated fair value amounts.
 
The following presents the estimated fair values of financial instruments as of the dates indicated (dollars in thousands):
 
                                 
    December 31, 2007     December 31, 2006  
    Carrying
    Estimated
    Carrying
    Estimated
 
    Amount     Fair Value     Amount     Fair Value  
 
Financial Assets:
                               
Cash and cash equivalents
  $ 561,832     $ 561,832     $ 541,725     $ 541,725  
Securities classified as trading
    1,222,543       1,222,543       542,731       542,731  
Securities classified as available for sale
    6,105,976       6,105,976       4,900,514       4,900,514  
Loans held for sale
    3,776,904       3,814,008       9,467,843       9,565,821  
Loans held for investment
    16,055,911       15,647,700       10,114,823       10,184,055  
Investment in FHLB stock
    676,077       676,077       762,054       762,054  
Financial Liabilities:
                               
Deposits
    17,815,243       17,823,350       10,898,006       10,673,718  
Advances from the FHLB
    11,188,800       11,355,215       10,412,800       10,409,767  
Other borrowings
    652,778       461,336       4,637,000       4,679,943  
Derivative Financial Instruments:
                               
Commitments to purchase and originate loans
    7,713       7,713       (9,751 )     (9,751 )
Commitments to sell loans and securities
    51,291       51,291       (376 )     (376 )
Forward rate agreements
    (2,780 )     (2,780 )     8,355       8,355  
Interest rate swaps
    (69,292 )     (69,292 )     38,507       38,507  
Interest rate swaptions
    485,622       485,622       168,835       168,835  
Interest rate caps, floors, flooridors and futures
    (36,969 )     (36,969 )     13,409       13,409  
Swap spreadlocks
    (2,590 )     (2,590 )            
                                 
Total derivative financial instruments
  $ 432,995     $ 432,995     $ 218,979     $ 218,979  
                                 


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The following describes the methods and assumptions we use in estimating fair values:
 
Cash and Cash Equivalents.  Carrying amount represents fair value.
 
Securities Classified as Trading and Available for Sale.  Carrying amount represents fair value. Fair value is estimated using quoted market prices or by discounting future cash flows using assumptions for prepayment rates, market yield requirements and credit losses.
 
Loans Held for Sale and Held for Investment.  The fair value of loans held for sale and held for investment is estimated by considering: 1) quoted market prices for TBA securities (for agency-eligible loans); 2) recent transaction settlements or traded but unsettled transactions for similar assets; 3) recent third party market transactions for similar assets; and 4) modeled valuations using assumptions the Company believes a reasonable market participant would use in valuing similar assets (assumptions may include loss rates, prepayment rates, interest rates, volatilities, mortgage spreads). Certain portfolio valuation within the loans held for investment line, namely builder and consumer construction, are solely based on present value models as no markets or transaction exists for comparison.
 
Loans Held for Investment.  Fair value is estimated using quoted market prices or by discounting future cash flows using assumptions for prepayment rates, market yield requirements and credit losses.
 
Investment in FHLB Stock.  The carrying amount represents the fair value. FHLB stock does not have a readily determinable fair value, but can be sold back to the FHLB at its par value with stated notice.
 
Deposits.  The fair value of time deposits and transaction accounts is determined using a cash flow analysis. The discount rate for time deposits is derived from the rate currently offered on alternate funding sources with similar maturities. The discount rate for transaction accounts is derived from a forward LIBOR curve plus a spread. Core deposit intangibles are included in the valuation.
 
Advances from FHLB.  The fair value of advances from FHLB is valued using a cash flow analysis. The discount rate is derived from the rate currently offered on similar borrowings.
 
Other Borrowings.  Fair values are determined by estimating future cash flows and discounting those using interest rates currently available to us on similar borrowings.
 
Commitments to Purchase and Originate Loans.  Fair value is estimated based upon the difference between the current value of similar loans and the price at which we have committed to purchase or originate the loans, subject to the anticipated loan funding probability, or fallout factor. The fair value represents the amount of change in value since the inception of the commitments and does not include initial value inherent at origination.
 
Commitments to Sell Loans and Securities.  We utilize forward commitments to hedge interest rate risk associated with loans held for sale and commitments to purchase loans. Fair value of these commitments is determined based on the difference between the settlement values of the commitments and the quoted market values of the securities.
 
Forward Rate Agreements, Interest Rate Swaps, Interest Rate Swaptions, Caps, Floors, Flooridors, Futures, and Put Options.  Valuing forward rate agreements involves forecasting forward mortgage and swap yields using current interest rates and comparing the value of each instrument versus market pricing indications. Fair value for the caps, floors, flooridors, and put options is estimated based upon specific characteristics of the option being valued, such as the underlying index, strike rate, and time to expiration, along with quoted market levels of implied volatility for similar instruments. Interest rate and Eurodollar futures are traded on the Chicago Board of Trade and market pricing is readily available and continuously quoted on systems such as Bloomberg. Fair value for interest rate swap and interest rate swaption agreements is estimated using discounted cash flow analyses based on expectations of rates over the life of the interest rate swap or interest rate swaption as implied by the forward swap curve.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Further, we have identified: 1) intermediate term fixed rate or ARM loans that are subject to future payment increases; 2) pay option ARM loans that permit negative amortization; and 3) loans with combined loan-to-value ratios above 80%, underlying our assets whose contractual terms may give rise to a concentration of credit risk and increase our exposures to risk of nonpayment or realization.
 
The following details the unpaid principal balance of these loans at December 31, 2007 and the related asset carrying value (dollars in thousands):
 
                                                                 
                Non-Investment Grade
    Non-Investment Grade
 
    SFR Mortgage Loans HFI     Mortgage Servicing Rights     Securities     Residuals  
    UPB of
    % of
    UPB of
    % of
    UPB of
    % of
    UPB of
    % of
 
   
Collateral
    Collateral     Collateral     Collateral     Collateral     Collateral     Collateral     Collateral  
 
Hybrid, Option ARM, and All Other ARM Loans:
                                                               
Hybrid 2/1
  $ 398,443       3.42 %   $           $           $        
Hybrid 3/1
    341,927       2.93 %     3,573,134       2.18 %     734,523       3.75%       323,314       3.23%  
Hybrid 5/1
    3,626,862       31.08 %     38,902,096       23.68 %     5,715,243       29.20%       274,831       2.75%  
Hybrid 7/1
    852,157       7.30 %     7,483,083       4.56 %     1,502,742       7.68%       1,684       0.02%  
Hybrid 10/1
    782,364       6.71 %     10,987,108       6.69 %     2,458,722       12.56%       1,493       0.01%  
Option ARMs
    2,973,888       25.49 %     27,170,661       16.54 %                        
All Other ARMs
    332,406       2.85 %     4,963,320       3.02 %     2,114,097       10.80%       2,838,346       28.35%  
                                                                 
Total
  $ 9,308,047       79.78 %   $ 93,079,402       56.67 %   $ 12,525,327       63.99%     $ 3,439,668       34.36%  
                                                                 
Loans with Original Combined Loan-to-Value (“CLTV”) Ratios Above 80%:
                                                               
>80% — =90%
  $ 1,702,777       14.60 %   $ 27,831,347       16.95 %   $ 2,298,651       11.74%     $ 2,714,404       27.12%  
>90% — =100%
    1,669,367       14.31 %     38,536,888       23.46 %     915,778       4.68%       2,561,318       25.58%  
>100%.
    9,752       0.08 %     29,921       0.02 %     4,282       0.02%       5,663       0.06%  
                                                                 
Total
  $ 3,381,896       28.99 %   $ 66,398,156       40.43 %   $ 3,218,711       16.44%     $ 5,281,385       52.76%  
                                                                 
All Underlying Single Family Residential Mortgage Loans and HELOCs:
                                                               
Collateral
  $ 11,667,013             $ 164,236,946             $ 19,573,334             $ 10,010,457          
                                                                 
Assets
  $ 11,411,464             $ 2,343,165             $ 155,748             $ 116,414          
                                                                 
 
Our mortgage servicing rights related to reverse mortgages of $152.2 million with underlying collateral of $17.5 billion at December 31, 2007, were not included in the table above as these loans do not represent significant risk of nonpayment.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
NOTE 16 — NON-INTEREST EXPENSE
 
The following presents a summary of non-interest expense for the years indicated (dollars in thousands):
 
                         
    Year Ended December 31  
    2007     2006     2005  
 
Salaries and related
  $ 770,429     $ 689,742     $ 552,550  
Premises and equipment
    107,112       79,102       55,424  
Data processing
    83,490       64,826       45,341  
Office and related
    64,471       68,730       50,891  
Loan purchase and servicing costs
    58,093       55,055       42,739  
Operations and sale of foreclosed assets
    46,198       3,958       2,364  
Professional services
    44,066       35,838       29,237  
Advertising and promotion
    34,181       44,369       44,959  
Litigation settlement
                9,000  
Other
    24,857       13,586       10,391  
Deferral of expenses under SFAS 91
    (259,206 )     (266,246 )     (224,399 )
                         
Total operating expenses
    973,691       788,960       618,497  
Amortization of other intangible assets
    1,720       1,123       591  
                         
Total non-interest expense
  $ 975,411     $ 790,083     $ 619,088  
                         
 
NOTE 17 — INCOME TAXES
 
The following presents the income tax provision (benefit) composition for the years indicated (dollars in thousands):
 
                         
    Year Ended December 31  
    2007     2006     2005  
 
Current tax (benefit) expense
                       
Federal
  $     $ (35,016 )   $ 18,654  
State
          2,468       6,966  
                         
Total current tax (benefit) expense
          (32,548 )     25,620  
                         
Deferred tax (benefit) expense
                       
Federal
    (318,823 )     219,174       139,312  
State
    (61,237 )     25,941       27,057  
                         
Net deferred tax (benefit) expense
    (380,060 )     245,115       166,369  
                         
Total income tax (benefit) expense
  $ (380,060 )   $ 212,567     $ 191,989  
                         


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The following presents the tax effect of temporary differences that gave rise to significant portions of deferred tax assets and liabilities as of the dates indicated (dollars in thousands):
 
                 
    December 31  
    2007     2006  
 
Deferred tax assets
               
Net operating losses and credits
  $ 547,456     $ 12,988  
Allowance for loan losses
    151,697       25,399  
Mortgage-backed securities
    52,442        
Compensation
    46,041       22,927  
State taxes
    41,078       33,403  
Interest receivable
    18,759       2,815  
Other, net
          61  
                 
Total deferred tax assets
    857,473       97,593  
                 
Deferred tax liabilities
               
Mortgage servicing rights
    (948,751 )     (676,486 )
Mortgage-backed securities
          (1,778 )
FHLB stock
    (38,641 )     (27,601 )
Other
    (4,977 )      
                 
Total deferred tax liabilities
    (992,369 )     (705,865 )
                 
Deferred tax liability, net
  $ (134,896 )   $ (608,272 )
                 
 
As of December 31, 2007, the Company had a net operating loss (“NOL”) carryforward for federal income tax purposes of approximately $1.3 billion which expires in 2028. The NOL carryforward for state income tax purposes of approximately $1.4 billion has various expirations ranging from five to twenty years through the year 2028.
 
The effective income tax rate differed from the federal statutory rate for the years indicated as follows:
 
                 
    Year Ended December 31  
    2007     2006  
 
Federal statutory rate
    35.0 %     35.0 %
State income taxes, net of federal tax effect
    4.1 %     3.3 %
                 
Effective income tax rate
    39.1 %     38.3 %
                 
 
The effective income tax rate on earnings was 39.1% and 38.3% for the years ended December 31, 2007 and 2006, respectively. The increase was due primarily to the fact that 2006 included the cumulative effect of a reduction in the state income tax rate on the net deferred tax liability.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
NOTE 18 — EARNINGS (LOSS) PER SHARE
 
The following is a reconciliation of the numerator and denominator of the basic and diluted earnings (loss) per share calculation for the years indicated (dollars in thousands, except per share data):
 
                         
    Earnings
    Average Shares
    Per Share
 
    (Numerator)     (Denominator)     Amount  
 
Year Ended December 31, 2007
                       
Basic loss
  $ (614,808 )     74,261     $ (8.28 )
Effect of stock options, restricted stock and warrants(1)
                 
                         
Diluted loss(1)
  $ (614,808 )     74,261     $ (8.28 )
                         
Year Ended December 31, 2006
                       
Basic earnings
  $ 342,929       67,701     $ 5.07  
Effect of stock options, restricted stock and warrants
          3,417       (0.25 )
                         
Diluted earnings
  $ 342,929       71,118     $ 4.82  
                         
Year Ended December 31, 2005
                       
Basic earnings
  $ 293,128       62,760     $ 4.67  
Effect of stock options, restricted stock and warrants
          3,355       (0.24 )
                         
Diluted earnings
  $ 293,128       66,115     $ 4.43  
                         
 
 
(1) Due to the net loss for the year ended December 31, 2007, no potentially dilutive shares are included in the diluted loss per share calculation as including such shares in the calculation would be anti-dilutive.
 
In November 2001, we issued 3,500,000 warrants, each convertible into 1.5972 shares of IndyMac Bancorp’s common stock, as part of the WIRES offering (described more in detail in “Note 11 — Other Borrowings”). At December 31, 2007, there were 895,636 warrants remained outstanding at an average exercise price of $31.78 per share. For December 31, 2006 and 2005, there were 935,636 and 3,413,100 warrants remained outstanding at an average exercise price of $31.68 per share and $31.59 per share, respectively. Outstanding warrants were included in our 2006 and 2005 dilutive earnings per share calculation.
 
Stock options to purchase 4,457,262 shares of common stock at a weighted average exercise price of $30.20 were outstanding at December 31, 2007. For December 31, 2006 and 2005, there were outstanding options to purchase 56,100 and 47,000 shares of common stock at weighted average exercise price of $44.86 and $44.09, respectively. These stock options were not included in the computation of diluted earnings per share because the stock options’ exercise prices were greater than the average market price of the common stock and, therefore, the effect would be anti-dilutive.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
NOTE 19 — ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
 
The following presents the balance in accumulated other comprehensive income (loss) for each component for the years indicated (dollars in thousands):
 
                         
    Year Ended December 31  
    2007     2006     2005  
 
Net unrealized loss on mortgage-backed securities available for sale:
                       
AAA-rated agency securities
  $ (566 )   $ (387 )   $ (141 )
AAA-rated non-agency securities
    (58,885 )     (18,595 )     (26,219 )
Other investment and non-investment grade securities
    (56,777 )     523       1,354  
Residual securities
                626  
                         
Net unrealized loss on mortgage-backed securities available for sale
    (116,228 )     (18,459 )     (24,380 )
Net unrealized (loss) gain on derivatives used in cash flow hedges
    (21,734 )     (6,812 )     9,223  
Change in pension liability
    (1,259 )     (6,168 )      
                         
Total
  $ (139,221 )   $ (31,439 )   $ (15,157 )
                         
 
The following presents the changes to accumulated other comprehensive loss and the related tax effect for each component (dollars in thousands):
 
                         
    Year Ended December 31  
    2007     2006     2005  
 
Net unrealized (loss) gain on mortgage-backed securities available for sale
  $ (160,540 )   $ 9,987     $ (27,658 )
Related tax benefit (expense)
    62,771       (4,066 )     10,925  
Net (loss) gain on derivatives used in cash flow hedges
    (24,503 )     (26,430 )     36,165  
Related tax benefit (expense)
    9,581       10,395       (14,285 )
Change in pension liability
    8,061       (10,128 )      
Related tax (expense) benefit
    (3,152 )     3,960        
                         
Change to accumulated other comprehensive income (loss)
  $ (107,782 )   $ (16,282 )   $ 5,147  
                         
 
NOTE 20 — COMMITMENTS AND CONTINGENCIES
 
Legal Matters
 
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. Certain of such actions include claims for breach of contract, restitution, compensatory damages, punitive damages and other forms of relief. The Company reviews these actions on an on-going basis and follows the provisions of FASB Statement No. 5, “Accounting for Contingencies” when making accrual and disclosure decisions. When assessing reasonably possible and probable outcomes, the Company bases its decisions on the evidence discovered and in its possession, the strength of probable witness testimony, the viability of its defenses and the likelihood of prevailing at trial or resolving the matter through alternative dispute resolution. Due to the difficulty of predicting the outcome of such actions, the Company can give no assurance that it will prevail on all claims made against it; however, 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


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
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.
 
Commitments
 
We enter into a number of commitments in the normal course of business. These commitments expose us to varying degrees of credit and market risk and are subject to the same credit and risk limitation reviews as those recorded on the consolidated balance sheets.
 
The following types of non-derivative commitments were outstanding as of the dates indicated (dollars in thousands):
 
                 
    December 31,  
    2007     2006  
 
Undisbursed loan commitments:
               
Reverse mortgages
  $ 349,208     $ 426,977  
Builder construction
    465,688       858,525  
Consumer construction
    1,148,188       1,317,346  
HELOC
    1,573,522       1,582,748  
Revolving warehouse lending
    379,037       465,222  
Letters of credit
    4,308       14,042  
 
Our Homebuilder Division issues standby letters of credit to municipalities to guarantee the performance of improvements related to tract construction projects. The risk of loss on the standby letters of credit is mitigated as the funds to complete the improvements are included in the construction loan balance and supported by the underlying collateral value. We have not incurred any loss on these standby letters of credit since the inception of this practice.
 
Leases
 
We lease office facilities and equipment under lease agreements extending through 2016. Future minimum annual rental commitments under these non-cancelable operating leases, with initial or remaining terms of one year or more, are as follows for the years indicated (dollars in thousands):
 
         
Year Ended December 31
     
 
2008
  $ 51,536  
2009
    46,494  
2010
    38,558  
2011
    33,288  
2012
    23,967  
Thereafter
    71,594  
         
Total
  $ 265,437  
         
 
Sublease rental income totaling $2.3 million reduced the above rental commitments. Rental expense, net of sublease income, for all operating leases was $52.6 million, $33.5 million, and $22.0 million, in 2007, 2006, and 2005, respectively.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
NOTE 21 — RELATED PARTY LOANS
 
At December 31, 2007 and 2006, we had $1.6 million and $1.7 million, respectively, in notes receivable from employees. There were no such loans outstanding with directors. These loans have varying interest rates and terms and were mostly secured by Indymac stock or real estate.
 
NOTE 22 — REGULATORY REQUIREMENTS
 
The banking industry, in general, is heavily regulated. As a savings and loan holding company, we are subject to regulation by the Office of Thrift Supervision (“OTS”), and Indymac Bank is subject to regulation by the OTS and the Federal Deposit Insurance Corporation (“FDIC”). The economic and political environment influence regulatory policies, and as such, any or all of our business activities are subject to change if and when our primary regulators change the policies and regulations. We are also subject to inspection and examination by the OTS and the FDIC.
 
Federal Reserve Board regulations require depository institutions to maintain certain deposit reserve balances. Indymac Bank is a depository institution required to maintain deposit reserves under the Federal Reserve Board regulations. At December 31, 2007, Indymac Bank’s deposit reserve balance of $4.7 million, included in “Cash and cash equivalents” on the consolidated balance sheets, met the required level.
 
Indymac Bank’s primary federal regulatory agency, the Office of Thrift Supervision (“OTS”), requires savings associations to satisfy three minimum capital ratio requirements: tangible capital, Tier 1 (core) capital and risk-based capital. To meet general minimum adequately capitalized requirements, a savings association must maintain (1) a tangible capital ratio of 1.5% of tangible assets; (2) a Tier 1 (core) capital ratio of 3% of adjusted total assets for strong rated associations that are not anticipating or experiencing significant growth and have well-diversified risks, including no undue interest rate exposure, excellent asset quality, high liquidity, and good earnings, and 4% for others; and (3) a total risk-based capital ratio of 8% of risk-weighted assets. Most associations are expected to maintain capital levels in excess of the above-mentioned capital levels. The OTS regulations also specify minimum requirements to be considered a “well-capitalized institution.” A “well-capitalized” savings association must have a total risk-based capital ratio of at least 10% of risk-weighted assets, a Tier 1 risk-based capital ratio of at least 6% of risk-weighted assets, and a Tier 1 (core) capital ratio of at least 5% of adjusted total assets. In order not to be deemed “critically undercapitalized” and therefore subject to immediate remedial action, a savings association must exceed a tangible equity to tangible assets ratio of 2%. As of December 31, 2007, Indymac Bank met all of the requirements of a “well-capitalized” institution under the general regulatory capital regulations.
 
The Company’s business is primarily focused on single-family lending and the related production and sale of loans. As such, the accumulation of MSRs is a large component of our strategy. As of December 31, 2007, the capitalized value of MSRs was $2.5 billion. OTS regulations generally impose higher capital requirements on MSRs that exceed total Tier 1 capital. These higher capital requirements could result in lowered returns on our retained assets and could limit our ability to retain servicing assets. While management believes compliance with the capital limits on MSRs will not materially impact future results, no assurance can be given that our plans and strategies will be successful.
 
In the second quarter of 2007, the Bank received $491 million in net proceeds from the issuance of 20 million shares of Perpetual Non-Cumulative Fixed Rate Preferred Stock with a liquidation preference of $25 per value (the “Series A Preferred Stock”). Dividends, when declared by Indymac Bank’s Board of Directors, are payable quarterly at a rate of 8.5%. At the option of Indymac Bank, the Series A Preferred Stock may be redeemed on or after June 15, 2017 at $25 per share plus any declared and unpaid dividends. The Series A Preferred Stock qualifies as Tier 1 (core) capital of the Bank under the OTS’s applicable regulatory capital regulations.
 
In December 2006, the federal bank and thrift regulatory agencies issued an interim decision that any amounts reported in AOCI resulting from the adoption of FASB Statement No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans”, an amendment of FASB Statements No. 87, 88, 106 and 132(R)


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
(“SFAS 158”). SFAS 158 should be excluded from regulatory capital until the regulatory agencies determine otherwise. As a result, $4.9 million in AOCI was excluded from our regulatory capital at December 31, 2006.
 
The following presents Indymac Bank’s actual and required capital ratios and the minimum required capital ratios to be categorized as “well-capitalized” as of the dates indicated (dollars in thousands):
 
                                 
    Capital Ratios  
    Tangible     Tier 1 (Core)     Tier 1 Risk-Based     Total Risk-Based  
 
December 31, 2007
                               
As reported on Thrift Financial Report
    6.24 %     6.24 %     9.56 %     10.81 %
Well-capitalized minimum requirement
    2.00 %     5.00 %     6.00 %     10.00 %
Excess over well-capitalized minimum requirement
  $ 1,367,732     $ 399,280     $ 689,633     $ 157,907  
December 31, 2006
                               
As reported on Thrift Financial Report
    7.39 %     7.39 %     11.40 %     11.77 %
Well-capitalized minimum requirement
    2.00 %     5.00 %     6.00 %     10.00 %
Excess over well-capitalized minimum requirement
  $ 1,533,111     $ 679,311     $ 877,511     $ 288,242  
 
IndyMac Bancorp, the holding company for Indymac Bank, is substantially dependent upon dividends from the Bank for cash used to pay dividends on common stock and other cash outflows. We are required to seek approval from the OTS in order to pay dividends from the Bank to the holding company. There is no assurance the Bank will be able to pay such dividends in the future or that the OTS will continue to grant approvals. While the holding company maintains cash and an unsecured line of credit to manage its liquidity, a disruption in dividends from the Bank could cause the holding company to reduce or eliminate the dividends paid on common stock.
 
Under the capital distribution regulations, a savings association that is a subsidiary of a savings and loan holding company must notify the OTS of an association capital distribution at least 30 days prior to the declaration of a dividend or the approval by the Board of Directors of the proposed capital distribution. The 30-day period provides the OTS an opportunity to object to the proposed distribution if it believes that the distribution would not be advisable.
 
An application to the OTS for specific approval to pay a dividend, rather than the notice procedure described above, is required if: (a) the total of all capital distributions made during a calendar year (including the proposed distribution) exceeds the sum of the institution’s year-to-date net income and its retained income for the preceding two years; (b) the institution is not entitled under OTS regulations to “expedited treatment” (which is generally available to institutions the OTS regards as well run and adequately capitalized); (c) the institution would not be at least “adequately capitalized” following the proposed capital distribution; or, (d) the distribution would violate an applicable statute, regulation, agreement, or condition imposed on the institution by the OTS.
 
In addition to applicable OTS regulatory requirements, Indymac Bank is required to maintain compliance with various servicing covenants such as a minimum net worth requirement. Management believes Indymac Bank was in compliance with all material financial covenants as of December 31, 2007 and 2006.
 
NOTE 23 — BENEFIT PLANS
 
Stock Incentive Plans
 
The Company has two stock incentive plans, the 2002 Incentive Plan, as amended and restated, and the 2000 Stock Incentive Plan, as amended (collectively, the “Plans”), which provide for the granting of non-qualified and incentive stock options, restricted and performance stock awards, and other awards to employees (including officers) and directors. On April 25, 2006, the 2002 Incentive Plan, as amended and restated, was approved by


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
shareholders to increase the total number of shares of common stock reserved and available for issuance from 6,000,000 to 11,200,000. Each share issued pursuant to a full value award (such as restricted stock) will reduce the number of shares of common stock available for future grant by 3.5 shares. The term of stock options granted under the 2002 Incentive Plan (the “Plan”) was reduced from ten years to seven years, and the Company is no longer able to grant stock appreciation rights, bonus stock, stock units, performance shares or performance units under the Plan.
 
Stock options granted under the Plans have an exercise price equal to the fair market value of the underlying common stock on the date of grant, and generally vest based on one, three or five years of continuous service. Grants issued after April 25, 2006 will expire in seven years from the grant date, while grants issued prior to April 25, 2006 continue to have a ten-year term. Certain stock option and share awards provide for accelerated vesting if there is a change in control (as defined in the Plans). The fair value of each stock option award is estimated on the date of grant using an enhanced binomial lattice model.
 
Prior to January 1, 2006, the Company accounted for the Plans under the recognition and measurement provisions of APB 25 and related Interpretations, as permitted by SFAS 123. Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS 123(R) using the modified-retrospective-transition method. Under this method, compensation cost recognized for 2006 includes compensation cost for all stock options granted prior to, but not yet vested as of January 1, 2006, and all stock options granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of Statements 123 and 123(R), respectively.
 
The fair value of each stock option award is estimated on the date of grant. For grants issued on and after January 1, 2006, the fair value is determined using an enhanced binomial lattice model. For stock options granted prior to January 1, 2006, the fair value of these awards was based on the fair value calculated for purposes of the SFAS 123 pro-forma disclosures which used the Black Scholes option pricing model.
 
The following presents the assumptions used in the valuations for stock options granted during the years indicated:
 
             
    December 31,
    2007   2006   2005
 
Expected volatility
  26.68-30.20%   28.11-28.44%   25.96%-29.42%
Expected dividends
  5.08-6.76%   4.00-4.60%   3.52-4.65%
Weighted average expected term (in years)
  5.20-5.50   6.89-7.34   5.00
Risk-free rate
  4.58-4.82%   4.54-4.73%   4.16-4.64%
 
Expected volatilities are based on the historical volatility of the Company’s common stock and other factors. For the Black Scholes valuation model, the expected term of the stock options is estimated based on historical option exercise activity. For the enhanced binomial valuation model, the Company uses historical data to estimate assumptions for expected stock option exercise and expected employee termination rates. The expected term of stock options granted is derived from the output of the binomial model and represents the period of time that stock options granted are expected to be outstanding. The range given above results from certain groups of employees exhibiting different behavior. The risk-free rate for periods within the contractual life of the stock option is based on the U.S. Treasury yield curve in effect at the time of grant.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The following presents the impact of stock option compensation cost to the statements of operations for the years indicated (dollars in thousands, except per share data):
 
                         
    Year Ended December 31,  
    2007     2006     2005  
 
Stock option compensation cost, before tax
  $ 7,943     $ 9,630     $ 12,109  
Stock option compensation cost, after tax
    5,230       5,951       7,098  
Effect on basic earnings per share
    0.07       0.09       0.11  
Effect on diluted earnings per share
    0.07       0.08       0.11  
 
The following presents stock option activity under the Plans for the year ended December 31, 2007 (dollars in thousands, except share data):
 
                                 
                Weighted
       
          Weighted-
    Average
       
          Average
    Remaining
       
          Exercise
    Contractual
    Aggregate
 
Stock Options:
  Shares     Price     Term     Fair Value  
 
Outstanding at December 31, 2006
    7,703,205     $ 26.31              
Granted
    1,088,913       29.61              
Exercised
    (143,542 )     24.60              
Canceled, forfeited and expired
    (125,288 )     35.58              
                                 
Outstanding at December 31, 2007
    8,523,288       26.62       4.90     $ 7.31  
                                 
Exercisable at December 31, 2007
    6,766,319       25.01       4.39       7.49  
                                 
 
The weighted average grant-date fair value of stock options granted during the years ended December 31, 2007, 2006 and 2005 were $5.43, $9.13 and $7.68, respectively. For the years ended December 31, 2007, 2006 and 2005, the total fair value of options exercised was $1.0 million, $5.7 million and $10.9 million, respectively.
 
The following presents nonvested shares activity for the year ended December 31, 2007:
 
                 
          Weighted-Average
 
          Grant-Date
 
          Fair Value
 
Nonvested Stock Options:
  Shares     per Share  
 
Outstanding at December 31, 2006
    1,668,512     $ 8.27  
Granted
    1,088,913       5.43  
Vested
    (946,981 )     8.02  
Canceled, forfeited and expired
    (53,475 )     7.92  
                 
Outstanding at December 31, 2007
    1,756,969       6.63  
                 
 
As of December 31, 2007, there was $6.0 million of total unrecognized compensation cost, net of estimated forfeitures, related to nonvested stock options under the Plans. That cost is expected to be recognized in less than three years. The total fair value of shares vested during the years ended December 31, 2007, 2006 and 2005, were $7.6 million, $12.8 million and $14.3 million, respectively.
 
Cash received from stock options exercised under the Plans for the years ended December 31, 2007, 2006 and 2005 was $3.5 million, $20.1 million and $31.5 million, respectively. The actual tax benefit for the tax deductions from stock option exercises totaled $0.7 million, $6.6 million and $15.7 million, for the years ended December 31, 2007, 2006 and 2005, respectively. To the extent the tax deductions exceed the amount previously expensed for


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
financial accounting purposes, the related tax benefit on the excess is credited to equity, but only if that benefit can be realized currently.
 
The Company recorded compensation cost of $9.0 million, $10.1 million and $5.6 million related to the restricted stock granted under the Plans for the years ended December 31, 2007, 2006 and 2005, respectively.
 
The following presents restricted stock activity under the Plans for the year ended December 31, 2007:
 
                 
          Weighted-Average
 
          Grant-Date
 
          Fair Value
 
Restricted Stock:
  Shares     per Share  
 
Outstanding at December 31, 2006
    889,117     $ 39.14  
Granted
    648,228       27.91  
Vested
    (163,851 )     37.22  
Canceled and forfeited
    (373,054 )     36.58  
                 
Outstanding at December 31, 2007
    1,000,440       33.13  
                 
 
Pension Plan and Other Postretirement Benefit Plan
 
Through December 31, 2002, Indymac Bank provided a defined benefit pension plan (the “DBP Plan”) to substantially all of its employees. Employees hired prior to January 1, 2003, with one or more years of service, are entitled to annual pension benefits beginning at normal retirement age (65 years of age) equal to a formula approximating 0.9% of final average compensation multiplied by credited service (not in excess of 35 years), subject to a vesting requirement of five years of service. Our policy is to contribute the amount actuarially determined to be necessary to pay the benefits under the DBP Plan, and in no event to pay less than the amount necessary to meet the minimum funding standards of employee. Employee Retirement Income Security Act of 1974 (“ERISA”). Employees hired after December 31, 2002 are not eligible for the DBP Plan.
 
In April 2007, the Board of Directors, at management’s recommendation, approved a resolution to freeze the DBP Plan effective May 31, 2007. Participants would no longer accrue additional benefits starting with the 2007 Plan year. As a result, we recognized a net pre-tax curtailment gain of $10.3 million ($6.3 million after tax) as a reduction to pension expense. This pre-tax curtailment gain was recorded in accordance with FASB Statement No. 88, “Employers’ Accounting for Settlements and Curtailments of Defined Benefit pension Plan and for Termination Benefits” and includes the gross pre-tax curtailment gain of $20.0 million related to pension benefits partially offset by approximately $8.1 million of actuarial net loss and prior service cost and $1.7 million of pre-curtailment pension expense.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The following sets forth the change in the pension benefit obligation, pension plan assets and accrued pension costs recognized in the accompanying consolidated balance sheets for the years indicated (dollars in thousands):
 
                 
    Year Ended December 31  
    2007     2006  
 
Change in benefit obligation
               
Projected benefit obligation, beginning of year
  $ 46,680     $ 37,895  
Service cost
    1,626       6,052  
Interest cost
    2,003       2,301  
SFAS 88 curtailment
    (20,000 )      
Benefits paid including expense
    (49 )     (30 )
Actuarial loss (gain)
    (4,008 )     462  
                 
Projected benefit obligation, end of year
  $ 26,252     $ 46,680  
                 
Accumulated benefit obligation, end of year
  $ 26,252     $ 28,228  
                 
Change in plan assets
               
Fair value of plan assets, beginning of year
  $ 34,817     $ 27,579  
Actual return on plan assets
    1,586       3,427  
Employer contributions
          3,841  
Benefits paid including expense
    (49 )     (30 )
                 
Fair value of plan assets, end of year
  $ 36,354     $ 34,817  
                 
Accrued pension costs
               
Funded status, end of year
  $ 10,102     $ (11,863 )
                 
 
Accrued pension cost was included in “Other assets” at December 31, 2007, and “Other liabilities” at December 31, 2006 on the consolidated balance sheets.
 
The following presents the components of net periodic expense for the DBP Plan for the years indicated (dollars in thousands):
 
                 
    Year Ended December 31  
    2007     2006  
 
Service cost
  $ 1,627     $ 6,052  
Interest cost
    2,003       2,301  
Expected return on assets
    (2,627 )     (2,212 )
Recognized actuarial loss
    48       376  
Amortization of prior service cost
    15       56  
                 
Net periodic expense
  $ 1,066     $ 6,573  
                 
 
Included in AOCI at December 31, 2006 were unrecognized prior service costs of $0.5 million and unrecognized actuarial losses of $7.5 million. These amounts were fully recognized in pension expense during the year ended December 31, 2007 when the DPB Plan was frozen. Accordingly, the Company is not required to fund the DBP Plan in 2007.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The following presents the weighted average assumptions used in computing the preceding information for the years indicated:
 
                 
    Year Ended December 31  
    2007     2006  
 
Benefit obligations:
               
Discount rate
    6.60 %     6.00 %
Rate of compensation increase
    N/A       4.00 %
Net periodic costs:
               
Discount rate
    6.00 %     6.00 %
Rate of compensation increase
    4.00 %     4.00 %
Expected return on assets
    7.50 %     7.50 %
 
The following presents the DBP Plan’s weighted average asset allocation as of the measurement date, by asset category, for the years indicated:
 
                 
    Year Ended December 31  
    2007     2006  
 
Bond and mortgage
    32 %     32 %
Large cap stock index
    68 %     68 %
                 
Total
    100 %     100 %
                 
 
The investment goals and the allocation of the plan assets are determined jointly by the Employee Benefits Fiduciary Committee and Principal Life Insurance Company, the investment manager of the Plan. The assets of the DBP Plan are invested to provide safety through diversification in a portfolio of equity investments, common stocks, bonds and other investments which may reflect varying rates of return. Only classes or categories of investments allowed by the Employee Retirement Income Security Act of 1974 (“ERISA”) as acceptable investment choices are considered. The overall return objective for the portfolio is a reasonable rate on a long-term basis that would balance the benefit obligations with the appropriate asset allocation mix consistent with the risk levels established by our Employee Benefits Fiduciary Committee.
 
The Company’s 2007 and 2006 pension expense was calculated based upon a number of actuarial assumptions, including an expected long-term rate of return on plan assets of 7.5% for both years. In developing the long-term rate of return assumption, historical asset class returns as well as expected returns were evaluated based upon broad equity and bond indices. The expected long-term rate of return on plan assets assumes an asset allocation of approximately 68% in equity and 32% in fixed income financial instruments. The Employee Benefits Fiduciary Committee regularly reviews the asset allocation with its plan investment manager and periodically rebalances the investment mix to achieve certain investment goals when considered appropriate. Actuarial assumptions, including the expected rate of return, are reviewed at least annually, and are adjusted as necessary.
 
The discount rate that was utilized for determining our pension obligation and net periodic cost was based on a review of long-term bonds that received one of the two highest ratings given by a recognized rating agency. The discount rate for our pension obligation remained the same at 6.00% in 2007.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The following indicates the benefits expected to be paid in each of the next five fiscal years, and in the aggregate for the five fiscal years thereafter (dollars in thousands):
 
         
Year Ended December 31
     
 
2008
  $ 210  
2009
    225  
2010
    291  
2011
    374  
2012
    466  
2013-2017
    3,798  
         
Total
  $ 5,364  
         
 
The Company adopted FASB Statement No. SFAS 158, “Employers’ Accounting for Defined Benefit Pensions and Other Postretirement Plans,” on December 31, 2006 and the following shows the incremental effect of applying the provisions of SFAS 158 on individual line items in the consolidated balance sheet at December 31, 2006 (dollars in thousands):
 
                         
    Before Application
          After Application
 
    of SFAS 158     Adjustments     of SFAS 158  
 
Accrued pension cost
  $ 3,802     $ 8,061     $ 11,863  
Accrued postretirement cost
          2,067       2,067  
Deferred income taxes
    612,232       (3,960 )     608,272  
Total liabilities
    27,460,880       6,168       27,467,048  
Accumulated other comprehensive loss
    (25,271 )     (6,168 )     (31,439 )
Total shareholders’ equity
    2,034,436       (6,168 )     2,028,268  
 
Defined Contribution Plan
 
We also offer a defined contribution plan (the “401(k) Plan”) covering substantially all of our employees. Employees with one full month of continuous service may contribute up to 40% of annual compensation to a maximum of $15,500 of pre-tax annual compensation in 2007. We may determine, at our discretion, the amount of employer matching contributions to be made. During 2007, 2006 and 2005, the Company matched, for eligible participants following the completion of one year of service, 75% of the first 3% of the annual compensation contributed by the employee and 25% of the second 3% of the annual compensation contributed by the employee to the 401(k) Plan. We contributed a total of $7.0 million, $8.4 million, and $6.3 million during the years ended December 31, 2007, 2006 and 2005, respectively. The employer matching contribution was made in cash.
 
NOTE 24 — PERPETUAL NON-CUMULATIVE PREFERRED STOCK
 
In the second quarter of 2007, Indymac Bank received approximately $491 million in net proceeds from the issuance of 20 million shares of Series A Perpetual Non-Cumulative Fixed Rate Preferred Stock with a $25.00 liquidation preference value (the “Series A Preferred Stock”) and distributed $100 million of the net proceeds to the Parent Company. As of December 31, 2007, $491 million is reflected as “Perpetual preferred stock in subsidiary” on the consolidated balance sheets.
 
Dividends, when declared by the Bank’s Board of Directors, are payable quarterly at a rate of 8.5%. At the option of the Bank, the Series A Preferred Stock may be redeemed on or after June 15, 2017 at $25 per share plus any declared and unpaid dividends. Outstanding shares of Series A Preferred Stock rank senior to the Bank’s common shares both as to dividends and liquidation preferences but do not have any voting rights.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
NOTE 25 — SHAREHOLDER RIGHTS PLAN
 
Our Board of Directors adopted a Shareholder Rights Plan (the “Rights Plan”) on October 17, 2001. The Board’s purpose in adopting the Rights Plan is to protect shareholder value in the event of an unsolicited offer to acquire us, particularly one that does not provide equitable treatment to all shareholders. In connection with the adoption of the Rights Plan, we declared a distribution of one right to purchase one one-hundredth of a share of Series A Junior Participating Preferred Shares (“Preferred Shares”) for each outstanding share of common stock, payable to the shareholders of record on November 1, 2001. These rights automatically become associated with outstanding shares of common stock on our books, and individual shareholders need take no action with respect thereto. The rights will not become exercisable unless an investor acquires 15 percent or more of our common shares, or announces a tender offer that would result in the investor owning 15 percent or more of our common shares or makes certain regulatory filings seeking authority to acquire 15 percent or more of our common shares. If someone does acquire 15 percent or more of our common shares, or acquires us in a merger or other transaction, each right would entitle the holder, other than the investor triggering the rights and related persons, to purchase common shares, or shares of an entity that acquires us, at half of the then current market price. The Board of Directors authorized and directed the issuance of one right with respect to each common share issued thereafter until the redemption date (as defined in the Rights Agreement). The terms of the rights are set forth in the Rights Agreement between us and the Bank of New York, as Rights Agent, dated as of October 17, 2001. The rights will expire at the close of business on October 17, 2011, unless we redeem them earlier. The Preferred Shares have a par value of $0.01 per share, are junior to all other series of our preferred shares, and are entitled to quarterly dividends at a rate equal to the dividends paid, if any, on 100 common shares. Each one one-hundredth of a Preferred Share entitles the holder to one vote on matters submitted to a vote of our shareholders. The Rights Plan can be terminated or amended by the Board at any time.


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INDYMAC BANCORP, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
NOTE 26 — QUARTERLY FINANCIAL DATA — UNAUDITED
 
The following presents selected quarterly financial data for the years indicated (dollars in thousands, except per share data):
 
                                 
    Quarter Ended  
    March 31     June 30     September 30     December 31  
 
2007
                               
Interest income
  $ 532,677     $ 554,477     $ 557,851     $ 542,702  
Interest expense
    397,607       405,233       415,673       402,452  
Net interest income
    135,070       149,244       142,178       140,250  
Provision for loan losses
    10,687       17,204       98,279       269,378  
Gain (loss) on sale of loans and securities, net
    112,196       54,683       (334,788 )     (616,166 )
Net earnings (loss)
    52,382       44,639       (202,717 )     (509,113 )
Earnings (loss) per share(1):
                               
Basic
  $ 0.72     $ 0.62     $ (2.77 )   $ (6.43 )
Diluted(2)
    0.70       0.60       (2.77 )     (6.43 )
                                 
                                 
2006
                               
Interest income
  $ 377,846     $ 412,211     $ 446,751     $ 514,208  
Interest expense
    250,636       282,057       310,040       381,562  
Net interest income
    127,210       130,154       136,711       132,646  
Provision for loan losses
    3,822       2,230       4,988       8,953  
Gain on sale of loans and securities, net
    138,584       209,917       179,193       160,842  
Net earnings
    79,849       104,659       86,180       72,241  
Earnings per share(1):
                               
Basic
  $ 1.24     $ 1.57     $ 1.25     $ 1.02  
Diluted
    1.18       1.49       1.19       0.97  
 
 
(1) Earnings per share are computed independently for each of the quarters presented. Therefore, the sum of the quarterly earnings per share may not equal the total for the year.
 
(2) Due to the net loss for the quarters ended September 30, 2007 and December 31, 2007, no potentially dilutive shares are included in the diluted loss per share calculations as including such shares in the calculations would be anti-dilutive.
 
NOTE 27 — SUBSEQUENT EVENT
 
In January 2008, the Company announced a further reduction in its global workforce of roughly 2,400 people, or 24% of overall workforce, spread throughout the Company, including a 27% reduction in staff with our outsourced and temporary vendors.


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