8-K 1 v37879e8vk.htm FORM 8-K e8vk
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
Form 8-K
 
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
Date of Report (Date of earliest event reported): February 12, 2008
 
INDYMAC BANCORP, INC.
(Exact name of registrant as specified in its charter)
 
         
Delaware   1-08972   95-3983415
(State or other jurisdiction   (Commission File Number)   (IRS Employer
of incorporation)       Identification No.)
 
888 East Walnut Street, Pasadena, California 91101-7211
(Address of Principal Executive Office)
 
Registrant’s telephone number, including area code: (800) 669-2300
 
 
Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions (see General Instruction A.2. below):
 
o Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425)
 
o Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)
 
o Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))
 
o Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))
 


 

 
TABLE OF CONTENTS
 
                 
        Page
 
      Results of Operations and Financial Condition     3  
      Regulation FD Disclosure     3  
        Forward-looking Statements     3  
        Management’s Discussion and Analysis of Financial Condition and Results of Operations     3  
         Overview     3  
         Selected Consolidated Financial Highlights     5  
         Narrative Summary of Consolidated Financial Results     6  
         Summary of Business Segment Results     9  
         Consolidated Risk Management Discussion     32  
         Expenses     48  
         Appendix A: Additional Quantitative Disclosures     49  
      Financial Statements and Exhibits     66  
        Consolidated Balance Sheets     66  
        Consolidated Statements of Operations     67  
        Exhibits     68  
    69  
 
Exhibit 99.1
    Press Release regarding IndyMac Bancorp, Inc. Earnings for the Three Months and Year Ended December 31, 2007        
 
Exhibit 99.2
    2007 Shareholder Letter of IndyMac Bancorp, Inc.         
 
Exhibit 99.3
    Webcast Presentation regarding IndyMac Bancorp, Inc. Earnings Review for the Three Months and Year Ended December 31, 2007        
 EXHIBIT 99.1
 EXHIBIT 99.2
 EXHIBIT 99.3


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ITEM 2.02.   RESULTS OF OPERATIONS AND FINANCIAL CONDITION
 
On February 12, 2008, IndyMac Bancorp, Inc., a Delaware corporation (“Indymac Bancorp”), issued an earnings press release announcing its results of operations and financial condition for the quarter and the year ended December 31, 2007. A copy of Indymac Bancorp’s press release is furnished as Exhibit 99.1 hereto. In addition, Indymac Bancorp’s 2007 Shareholder Letter is furnished as Exhibit 99.2 hereto.
 
On February 12, 2008, Indymac Bancorp will host a live webcast presentation in connection with its quarterly release of earnings. Indymac Bancorp’s webcast presentation is furnished as Exhibit 99.3 hereto.
 
ITEM 7.01.   REGULATION FD DISCLOSURE
 
FORWARD-LOOKING STATEMENTS
 
Certain statements contained in this Form 8-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 its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, and its reports on Form 8-K. For further information on our risk factors, please refer to “Risk Factors” on pages 72 to 80 in Indymac’s annual report on Form 10-K for the year ended December 31, 2006 (“2006 10-K”) and Part II Item 1A “Risk Factors” on page 82 to 83 on Form 10-Q for the quarter ended September 30, 2007. Accordingly, readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date they are made. 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. The following discussion addresses the Company’s financial condition and results of operations for the three months and year ended December 31, 2007.
 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
 
OVERVIEW
 
The U.S. mortgage industry experienced unprecedented disruption in 2007. A combination of credit tightening, rising interest rates 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 those 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


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a significant portion of our loans for sale to the government-sponsored entities (“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 closed-end second liens, home equity lines of credit (“HELOCs”), consumer and builder construction loans, and most non-conforming loan production. As a result, production results for the fourth quarter show significant declines from prior quarters and the prior year.
 
The fourth quarter was also severely impacted by worsening credit conditions as home prices and home sales decline. 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 held for investment (“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 80/20 loan products, increased significantly, and accordingly, we recorded a $144.6 million increase in our secondary market reserve.
 
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 the fourth quarter. For the three months ended December 31, 2007, Indymac had a consolidated net loss of $509.1 million. Regarding business segment performance1, the mortgage production division had a net loss of $115.9 million in the fourth quarter while the mortgage servicing division had earnings of $39.3 million. Combining mortgage production and servicing, the mortgage banking segment recorded a net loss of $95.0 million. The thrift segment also recorded a net loss of $186.4 million for the fourth quarter. 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 total mortgage banking segment is after divisional overhead but before corporate overhead.


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SELECTED CONSOLIDATED FINANCIAL HIGHLIGHTS
 
The following highlights the Company’s consolidated financial condition and results of operations for the periods indicated (dollars in millions, except per share data):
 
                                         
    Three Months Ended     Year Ended  
    December 31,
    December 31,
    September 30,
    December 31,
    December 31,
 
    2007     2006     2007     2007     2006  
    (Unaudited)     (Unaudited)        
 
Balance Sheet Information (at period end)(1)
                                       
Cash and cash equivalents
  $ 562     $ 542     $ 785     $ 562     $ 542  
Securities (trading and available for sale)
    7,328       5,443       5,732       7,328       5,443  
Loans held for sale
    3,777       9,468       14,022       3,777       9,468  
Loans held for investment
    16,454       10,177       8,553       16,454       10,177  
Allowance for loan losses
    (398 )     (62 )     (162 )     (398 )     (62 )
Mortgage servicing rights
    2,495       1,822       2,490       2,495       1,822  
Other assets
    2,516       2,105       2,313       2,516       2,105  
                                         
Total Assets
  $ 32,734     $ 29,495     $ 33,733     $ 32,734     $ 29,495  
                                         
Deposits
  $ 17,815     $ 10,898     $ 16,775     $ 17,815     $ 10,898  
Advances from Federal Home Loan Bank
    11,189       10,413       11,095       11,189       10,413  
Other borrowings
    652       4,637       2,189       652       4,637  
Other liabilities and preferred stock in subsidiary
    1,734       1,519       1,803       1,734       1,519  
                                         
Total Liabilities and Preferred Stock in Subsidiary
  $ 31,390     $ 27,467     $ 31,862     $ 31,390     $ 27,467  
                                         
Shareholders’ Equity
  $ 1,344     $ 2,028     $ 1,871     $ 1,344     $ 2,028  
                                         
Statement of Operations Information(1)
                                       
Net interest income
  $ 140     $ 133     $ 142     $ 567     $ 527  
Provision for loan losses
    (269 )     (9 )     (98 )     (396 )     (20 )
Gain (loss) on sale of loans
    (322 )     165       (251 )     (354 )     668  
Service fee income
    171       22       213       519       101  
Gain (loss) on MBS
    (294 )     (4 )     (94 )     (439 )     21  
Fee and other income
    20       13       46       107       50  
                                         
Net revenues (loss)
    (554 )     320       (42 )     4       1,347  
Total expenses
    (275 )     (211 )     (283 )     (999 )     (791 )
(Provision) benefit for income taxes
    320       (36 )     122       380       (213 )
                                         
Net earnings (loss)
  $ (509 )   $ 72     $ (203 )   $ (615 )   $ 343  
                                         
Operating Data
                                       
SFR mortgage loan production
  $ 12,089     $ 25,946     $ 16,816     $ 76,979     $ 89,951  
Total loan production(2)
    12,301       26,328       17,062       78,316       91,698  
Mortgage industry market share(3)
    2.61 %     3.76 %     3.04 %     3.29 %     3.30 %
Pipeline of SFR mortgage loans in process (at period end)
  $ 7,506     $ 11,821     $ 7,421     $ 7,506     $ 11,821  
Loans sold
    13,425       23,417       13,009       71,164       79,049  
Loans sold/SFR mortgage loan production
    111 %     90 %     77 %     92 %     88 %
SFR mortgage loans serviced for others (at period end)(4)
  $ 181,724     $ 139,817     $ 173,915     $ 181,724     $ 139,817  
Total SFR mortgage loans serviced (at period end)
    198,170       155,656       192,629       198,170       155,656  
Average number of full-time equivalent employees (“FTEs”)
    9,994       8,477       9,890       9,518       7,935  
 
                                       
Per Common Share Data
                                       
Basic earnings (loss) per share(5)
  $ (6.43 )   $ 1.02     $ (2.77 )   $ (8.28 )   $ 5.07  
Diluted earnings (loss) per share(6)
    (6.43 )     0.97       (2.77 )     (8.28 )     4.82  
Dividends declared per share
    0.25       0.50       0.50       1.75       1.88  
Dividend payout ratio(7)
    (4 )%     52 %     (18 )%     (21 )%     39 %
Book value per share (at period end)
  $ 16.61     $ 27.78     $ 24.31     $ 16.61     $ 27.78  
Closing price per share (at period end)
    5.95       45.16       23.61       5.95       45.16  
Average Shares (in thousands):
                                       
Basic
    79,139       71,059       73,134       74,261       67,701  
Diluted
    79,139       74,443       73,134       74,261       71,118  
 
                                       
Performance Ratios
                                       
Return on average equity (annualized)
    (115.74 )%     14.56 %     (39.15 )%     (31.10 )%     19.09 %
Return on average assets (annualized)
    (5.63 )%     0.85 %     (2.18 )%     (1.71 )%     1.17 %
Net interest margin, consolidated
    1.80 %     1.76 %     1.78 %     1.81 %     2.02 %
Net interest margin, thrift(8)
    2.33 %     1.84 %     2.27 %     2.16 %     2.11 %
Mortgage banking revenue (“MBR”) margin on loans sold(9)
    (2.14 )%     0.91 %     (1.54 )%     (0.22 )%     1.06 %
Efficiency ratio(10)
    (93 )%     64 %     483 %     244 %     58 %
Operating expenses to total loan production
    2.15 %     0.80 %     1.58 %     1.24 %     0.86 %
 
                                       
Average Balance Sheet Data and Asset Quality Ratios
                                       
Average interest-earning assets
  $ 30,945     $ 29,868     $ 31,695     $ 31,232     $ 26,028  
Average assets
    35,851       33,765       36,833       35,969       29,309  
Average equity
    1,745       1,969       2,054       1,977       1,796  
Debt to equity ratio (at period end)(11)
    22.1:1       12.8:1       16.1:1       22.1:1       13.5:1  
Tier 1 (core) capital ratio (at period end)(12)
    6.24 %     7.39 %     7.48 %     6.24 %     7.39 %
Risk-based capital ratio (at period end)(12)
    10.50 %     11.72 %     11.79 %     10.50 %     11.72 %
Non-performing assets to total assets (at period end)(13)
    4.61 %     0.63 %     2.46 %     4.61 %     0.63 %
Allowance for loan losses to total loans held for investment (at period end)
    2.42 %     0.61 %     1.89 %     2.42 %     0.61 %
Allowance for loan losses to non-performing loans held for investment (at period end)
    30.44 %     57.51 %     47.64 %     30.44 %     57.51 %


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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) Total loan production includes newly originated commitments on builder construction loans, as well as commercial real estate loan production which started operations in March 2007.
 
(3) Mortgage industry market share is calculated based on our total single-family residential (“SFR”) mortgage loan production, both purchased (mortgage broker and banker and conduit) and originated (retail and mortgage broker and banker), in all channels (the numerator) divided by the Mortgage Bankers Association (“MBA”) January 14, 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 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 mortgage broker and banker and conduit channels) of the mortgages. Therefore, our market share calculation may not be mathematically precise, but it is consistent with industry calculations, which provide investors with a good view of our relative standing compared to the other top mortgage lending peers.
 
(4) 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.
 
(5) Net earnings (loss) for the period divided by weighted average basic shares outstanding for the period.
 
(6) Net earnings (loss) for the period divided by weighted average dilutive shares outstanding for the period. Due to the loss for the three months and year ended December 31, 2007, no potentially dilutive shares are included in loss per share calculations as including such shares in the calculation would be anti-dilutive.
 
(7) Dividend payout ratio represents dividends declared per share as a percentage of diluted earnings (loss) per share.
 
(8) Net interest margin, thrift, represents the combined margin for thrift, elimination and other, and corporate overhead.
 
(9) 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.
 
(10) Efficiency ratio is defined as operating expenses divided by net revenues, excluding provision for loan losses.
 
(11) In the debt to equity calculation, debt includes deposits. Preferred stock in subsidiary is excluded from the calculation.
 
(12) 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.
 
(13) Non-performing assets are non-performing loans plus foreclosed assets. Loans are generally placed on non-accrual status when they are 90 days past due.
 
NARRATIVE SUMMARY OF CONSOLIDATED FINANCIAL RESULTS
 
Three Months ended December 31, 2007 Compared to Three Months ended December 31, 2006
 
The Company recorded a net loss of $509.1 million, or $6.43 loss per diluted share, for the fourth quarter of 2007, compared with net earnings of $72.2 million, or $0.97 per diluted share, for the fourth quarter of 2006. The decline in profitability is mainly attributable to credit costs of $863 million versus $46 million in the fourth quarter of 2006, or a negative impact on earnings per share of $6.28. 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.


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SFR Mortgage Loan Production
 
Our total SFR mortgage loan production for the fourth quarter of 2007 dropped 53%, to $12.1 billion as compared to $25.9 billion for the fourth quarter of 2006, and $16.8 billion for the third quarter of 2007. This decline in volume is mainly reflected in the 99%, or $9.4 billion, drop in production from our conduit division from the fourth quarter of 2006 as we no longer used this division 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 $4.7 billion, or 37%, from the fourth quarter of 2006 as we migrated our production efforts to focus primarily on GSE-eligible loans. Compared to the third quarter of 2007, volume from the conduit channel declined 98%, or $2.3 billion and volume from the mortgage broker and banker channel went down by 24%, or $2.5 billion, compared to the third quarter of 2007. Our core mortgage professionals group, excluding the conduit channel, produced $9.2 billion in the fourth quarter of 2007, reflecting a reduction of 29% and 18% from the fourth quarter of 2006 and third quarter of 2007, respectively. Our retail channel continued to grow with production reaching $1.1 billion this quarter, up 93% from the third quarter of 2007. The servicing retention channel saw a decline of 8% and 11% from the fourth quarter of 2006 and third quarter of 2007, respectively. The pipeline of SFR mortgage loans in process ended at $7.5 billion, down 37% from $11.8 billion at December 31, 2006, and 1% from $7.4 billion at September 30, 2007.
 
Mortgage Banking Revenue Margin
 
Our MBR margin declined to a negative 2.14% for the quarter ended December 31, 2007 from a positive 0.91% for the quarter ended December 31, 2006, and negative 1.54% for the quarter ended September 30, 2007. This year over year MBR margin decline was primarily due to higher credit costs.
 
In the fourth quarter of 2007, we transferred loans with an original cost basis of $10.9 billion to held for investment 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 September 30, 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.
 
We sold a total of $13.4 billion loans and recorded a net loss on sale of $321.8 million in the fourth quarter of 2007. By comparison, we sold a total of $23.4 billion loans, which generated $165.0 million in gain on sale during the same period last year.
 
Other Credit Costs
 
For the HFI portfolio, provision for loan losses increased to $269.4 million for the fourth quarter of 2007 from $9.0 million for the fourth quarter of 2006, with the most significant increase being in our homebuilder division’s portfolio. We recorded $208.7 million in credit related valuation adjustments to our residual and non-investment grade MBS portfolio. We also recorded a $144.6 million reduction in gain on sale revenue to increase our secondary market reserve.
 
Mortgage Servicing Performance
 
We had a strong performance from our mortgage servicing division in the fourth quarter of 2007. This division benefited from the financial instruments we used to hedge against decline in market interest rates and from a continued slowing of prepayment speeds in the quarter. As a result, our mortgage servicing division recorded net earnings of $39.3 million, or a 43% return on equity (“ROE”).
 
Operating Expenses
 
Total operating expenses of $264.2 million for the fourth quarter of 2007 were up 25% from the same quarter a year ago and down 2% over the third quarter of 2007. The increase in operating expenses in the fourth quarter of 2007 from the same period a year ago was driven mainly by real estate owned (“REO”) related expenses. REO related expenses significantly increased to $29.1 million in the fourth quarter of 2007 from $2.5 million in the same


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period last year. This was primarily due to the $19.2 million of further write-downs on REOs resulting from the rapid decline in their values. Also, higher delinquencies in our portfolio resulted in increased foreclosures leading to higher REO related expenses.
 
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.
 
Total SFR mortgage loan production decreased 14%, to $77.0 billion and loan sales decreased 10%, to $71.2 billion during the year ended 2007 compared to the year ended 2006. Net revenues 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 HFS, HFI and credit risk securities portfolios. The change in product mix of loans sold also contributed to the decline in MBR margin.
 
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 and 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 same period last year. In addition, in the fourth quarter of 2007, we transferred loans with an original cost basis of $10.9 billion to held for investment 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 at September 30, 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.
 
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 our performance in hedging, as well as the growth in our servicing portfolio and slower prepayment rates. These increases were offset by a reduction in revenue from our mortgage-backed securities (“MBS”) portfolio. The MBS portfolio 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 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 the year ended December 31, 2006 to 9,518 for the year ended December 31, 2007, which was necessary to support the expansion of our retail lending group and growth in loan servicing and default management functions. Also, contributing to the increase in expenses are REO related expenses which significantly increased by $42.2 million. 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. In addition, we recorded severance charges of approximately $28 million in the third quarter of 2007 related to the right-sizing of our workforce.


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SUMMARY OF BUSINESS SEGMENT RESULTS
 
Indymac’s hybrid business model combines elements of mortgage banking and thrift investing. 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 loans, fees earned from origination, interest income earned while the loans are held for sale and servicing fees. On the thrift side, we generate core spread income from our investment portfolio of prime SFR mortgage loans, consumer construction loans and MBS.
 
We have developed a detailed reporting process that computes net earnings and ROE for our key business segments each reporting period and uses 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 divisions that earn the best returns for our shareholders.
 
We predominantly use Generally Accepted Accounting Principles (“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 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.
 
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 GAAP.
 
The following tables and discussion 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 tables summarize the Company’s financial results by segment for the periods 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  
Three Months Ended December 31, 2007
                                                               
Operating Results
                                                               
Net interest income
  $ 13,672     $ 86,582     $ 27,296     $ 127,550     $ (1,659 )   $ 125,891     $ 14,359     $ 140,250  
Provision for loan losses
          (141,475 )           (141,475 )           (141,475 )     (127,903 )     (269,378 )
Gain (loss) on sale of loans
    (121,332 )     7,417       (64,505 )     (178,420 )           (178,420 )     (143,395 )     (321,815 )
Service fee income (expense)
    100,399             70,251       170,650             170,650       869       171,519  
Gain (loss) on MBS
    (5,617 )     (231,994 )     (45,655 )     (283,266 )           (283,266 )     (11,085 )     (294,351 )
Other income (expense)
    13,179       5,298       795       19,272       (45 )     19,227       662       19,889  
                                                                 
Net revenues (expense)
    301       (274,172 )     (11,818 )     (285,689 )     (1,704 )     (287,393 )     (266,493 )     (553,886 )
Operating expenses
    218,935       30,786       17,594       267,315       39,457       306,772       20,235       327,007  
Severance charges
                            4,216       4,216             4,216  
Deferral of expenses under SFAS 91
    (64,984 )     (920 )           (65,904 )           (65,904 )     (670 )     (66,574 )
                                                                 
Pre-tax earnings (loss)
    (153,650 )     (304,038 )     (29,412 )     (487,100 )     (45,377 )     (532,477 )     (286,058 )     (818,535 )
                                                                 
Minority interests
    1,288       1,207       7,633       10,128       48       10,176       449       10,625  
                                                                 
Net earnings (loss)
  $ (94,952 )   $ (186,365 )   $ (25,455 )   $ (306,772 )   $ (27,683 )   $ (334,455 )   $ (174,658 )   $ (509,113 )
                                                                 
Performance Data
                                                               
Average interest-earning assets
  $ 7,139,814     $ 18,369,334     $ (74,625 )   $ 25,434,523     $ 794,050     $ 26,228,573     $ 4,716,833     $ 30,945,406  
Allocated capital
    750,459       703,176       1,849       1,455,484       27,819       1,483,303       261,882       1,745,185  
Loans produced
    11,719,915       498,691       N/A       12,218,606       N/A       12,218,606       82,569       12,301,175  
Loans sold
    16,567,639       3,106,312       (10,016,337 )     9,657,614       N/A       9,657,614       3,767,174       13,424,788  
MBR margin
    (0.56 )%     0.24 %     N/A       N/A       N/A       (1.55 )%     (3.67 )%     (2.14 )%
ROE
    (50 )%     (105 )%     N/A       (84 )%     N/A       (89 )%     (265 )%     116 %
Net interest margin
    N/A       1.87 %     N/A       1.99 %     N/A       1.90 %     1.21 %     1.80 %
Net interest margin, thrift. 
    N/A       1.87 %     N/A       N/A       N/A       2.33 %     N/A       N/A  
Average FTE
    7,852       391       349       8,592       1,155       9,747       247       9,994  
Three Months Ended December 31, 2006
                                                               
Operating Results
                                                               
Net interest income
  $ 22,063     $ 43,509     $ 23,095     $ 88,667     $ (2,870 )   $ 85,797     $ 46,849     $ 132,646  
Provision for loan losses
          (5,628 )           (5,628 )           (5,628 )     (3,325 )     (8,953 )
Gain (loss) on sale of loans
    152,966       10,921       (19,365 )     144,522             144,522       20,449       164,971  
Service fee income (expense)
    30,803             (8,235 )     22,568             22,568       (445 )     22,123  
Gain (loss) on MBS
    5,906       (4,861 )     843       1,888             1,888       (6,017 )     (4,129 )
Other income (expense)
    4,762       5,571       (494 )     9,839       513       10,352       2,494       12,846  
                                                                 
Net revenues (expense)
    216,500       49,512       (4,156 )     261,856       (2,357 )     259,499       60,005       319,504  
Operating expenses
    184,730       20,730       13,608       219,068       43,910       262,978       18,910       281,888  
Deferral of expenses under SFAS 91
    (66,087 )     (1,924 )     (655 )     (68,666 )           (68,666 )     (1,981 )     (70,647 )
                                                                 
Pre-tax earnings (loss)
    97,857       30,706       (17,109 )     111,454       (46,267 )     65,187       43,076       108,263  
                                                                 
Net earnings (loss)
  $ 59,382     $ 18,700     $ (3,898 )   $ 74,184     $ (28,177 )   $ 46,007     $ 26,234     $ 72,241  
                                                                 
Performance Data
                                                               
Average interest-earning assets
  $ 7,578,156     $ 13,473,878     $ (90,071 )   $ 20,961,963     $ 376,247     $ 21,338,210     $ 8,529,904     $ 29,868,114  
Allocated capital
    745,777       593,898       2,541       1,342,216       143,799       1,486,015       482,568       1,968,583  
Loans produced
    15,804,156       708,443       N/A       16,512,599       N/A       16,512,599       9,815,417       26,328,016  
Loans sold
    14,865,787       708,505       (2,049,366 )     13,524,926       N/A       13,524,926       9,892,509       23,417,435  
MBR margin
    1.21 %     1.54 %     N/A       N/A       N/A       1.26 %     N/A       0.91 %
ROE
    32 %     12 %     N/A       22 %     N/A       12 %     22 %     15 %
Net interest margin
    N/A       1.28 %     N/A       1.68 %     N/A       1.60 %     2.18 %     1.76 %
Net interest margin, thrift. 
    N/A       1.28 %     N/A       N/A       N/A       1.84 %     N/A       N/A  
Average FTE
    6,064       456       324       6,844       1,274       8,118       359       8,477  
Quarter to Quarter Comparison
                                                               
% change in net earnings
    (260 )%     N/M       N/M       N/M       2 %     N/M       N/M       N/M  
% change in capital
    1 %     18 %     (27 )%     8 %     (81 )%           (46 )%     (11 )%
 
 
(1) Included are eliminations, deposits, and treasury items. See the “Eliminations & 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 an after-tax loss of $95.0 million in the fourth quarter of 2007 compared with net earnings of $59.4 million in the same period last year. These lower results were caused by a large decline in earnings from our mortgage production division, which reported a $115.9 million after-tax loss this quarter, partially offset by very strong returns and growth in the mortgage servicing division.
 
The primary driver of the loss in the mortgage production division this quarter was the decline in the MBR margin from a positive 1.18% of loans sold in last year’s fourth quarter to a negative 0.66% of loans sold in this year’s fourth quarter. A large increase in production credit costs was the primary cause of this decline. Mortgage banking revenue for the production divisions was reduced by $255.1 million in pre-tax credit related costs this quarter representing a $224.3 million increase from $30.8 million in the fourth quarter of 2006. As credit conditions in the U.S. mortgage market have deteriorated, our loan production credit costs have increased. Thus, we discontinued the products where these losses were concentrated and stopped offering them. As a result, substantially all of the production credit losses we incurred this quarter 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 this quarter as it includes two start-up businesses, the retail lending channel and commercial mortgage banking that are currently unprofitable. These two businesses reported a combined after-tax loss of $20.4 million this quarter. We expect these businesses to contribute to mortgage banking profits next year.
 
Although worsening credit conditions and disrupted secondary markets were significant negatives for our production results this quarter, they improved the performance of our mortgage servicing division. These trends 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 the fourth quarter of this year compared with 20% in last year’s fourth quarter. 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 165% from $14.8 million in the fourth quarter of 2006 to $39.3 million in this year’s fourth quarter and resulted in a 43% return on the approximately $400 million of capital we have invested in this division.


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The following tables provide additional detail on total mortgage banking segment for the periods indicated (dollars in thousands):
 
                                         
                Consumer
    Commercial
    Total
 
    Mortgage
    Mortgage
    Mortgage
    Mortgage
    Mortgage
 
    Production
    Servicing
    Banking
    Banking
    Banking
 
    Division     Division     O/H(1)     Division     Segment  
 
Three Months Ended December 31, 2007
                                       
Operating Results
                                       
Net interest income
  $ 29,110     $ (16,017 )   $ (156 )   $ 735     $ 13,672  
Provision for loan losses
                             
Gain (loss) on sale of loans
    (132,045 )     15,871             (5,158 )     (121,332 )
Service fee income (expense)
    8,288       92,111                   100,399  
Gain (loss) on MBS
          (5,617 )                 (5,617 )
Other income (expense)
    14,357       820       (2,017 )     19       13,179  
                                         
Net revenues (expense)
    (80,290 )     87,168       (2,173 )     (4,404 )     301  
Operating expenses
    170,651       24,354       20,689       3,241       218,935  
Deferral of expenses under SFAS 91
    (61,733 )     (2,811 )           (440 )     (64,984 )
                                         
Pre-tax earnings (loss)
    (189,208 )     65,625       (22,862 )     (7,205 )     (153,650 )
                                         
Minority interests
    604       627       28       29       1,288  
                                         
Net earnings (loss)
  $ (115,923 )   $ 39,339     $ (13,951 )   $ (4,417 )   $ (94,952 )
                                         
Performance Data
                                       
Average interest-earning assets
  $ 5,723,649     $ 1,207,323     $ 2,512     $ 206,330     $ 7,139,814  
Allocated capital
    351,991       365,159       16,537       16,772       750,459  
Loans produced
    10,597,345       932,926       N/A       189,644       11,719,915  
Loans sold
    15,589,618       978,021       N/A             16,567,639  
MBR margin
    (0.66 )%     1.62 %     N/A       N/A       (0.56 )%
ROE
    (131 )%     43 %     N/A       (104 )%     (50 )%
Net interest margin
    2.02 %     N/A       N/A       1.41 %     N/A  
Average FTE
    6,024       259       1,504       65       7,852  
Three Months Ended December 31, 2006
                                       
Operating Results
                                       
Net interest income
  $ 26,284     $ (4,649 )   $ 428     $     $ 22,063  
Provision for loan losses
                             
Gain (loss) on sale of loans
    141,178       11,788                   152,966  
Service fee income (expense)
    6,455       24,348                   30,803  
Gain (loss) on MBS
          5,906                   5,906  
Other income (expense)
    631       3,273       858             4,762  
                                         
Net revenues (expense)
    174,548       40,666       1,286             216,500  
Operating expenses
    149,213       19,258       15,546       713       184,730  
Deferral of expenses under SFAS 91
    (63,162 )     (2,925 )                 (66,087 )
                                         
Pre-tax earnings (loss)
    88,497       24,333       (14,260 )     (713 )     97,857  
                                         
Net earnings (loss)
  $ 53,682     $ 14,818     $ (8,684 )   $ (434 )   $ 59,382  
                                         
Performance Data
                                       
Average interest-earning assets
  $ 6,859,347     $ 715,835     $ 2,974     $     $ 7,578,156  
Allocated capital
    437,290       291,241       17,246             745,777  
Loans produced
    14,794,426       1,009,730       N/A             15,804,156  
Loans sold
    14,210,702       655,085       N/A             14,865,787  
MBR margin
    1.18 %     1.80 %     N/A       N/A       1.21 %
ROE
    49 %     20 %     N/A       N/A       32 %
Net interest margin
    1.52 %     N/A       N/A       N/A       N/A  
Average FTE
    4,646       274       1,139       5       6,064  
Quarter to Quarter Comparison
                                       
% change in net earnings
    (316 )%     165 %     (61 )%     N/A       (260 )%
% change in equity
    (20 )%     25 %     (4 )%     N/A       1 %
 
 
(1) Includes mortgage production division overhead, servicing overhead and secondary marketing overhead of $(5.5) million, $(3.8) million and $(4.6) million, respectively, for the fourth quarter of 2007. For the fourth quarter of 2006, the mortgage production division overhead, servicing overhead and secondary marketing overhead were $(3.4) million, $(2.8) million and $(2.5) million, respectively.


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MORTGAGE PRODUCTION DIVISION
 
The mortgage production division originates loans through three divisions: consumer direct, mortgage professionals group (“MPG”) and Financial Freedom. 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 New York Mortgage Company (“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. Mortgage broker and banker is the largest channel in our MPG, funding loans originated through mortgage brokers and emerging mortgage bankers nationwide. This division also purchases closed loans — those already funded — on a flow basis from mortgage brokers, realtors, homebuilders, mortgage bankers and financial institutions.
 
The Financial Freedom division provides reverse mortgage products directly to seniors (age 62 and older) and through the mortgage broker and banker channel. Through this division, Indymac remains the leader in the fast growing reverse mortgage market. Financial Freedom also retains mortgage servicing rights (“MSRs”) and receives fees and ancillary revenues for servicing loans sold into the secondary market.


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The following tables provide details on the results for the mortgage production division of our mortgage banking segment for the periods 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  
Three Months Ended December 31, 2007
                                               
Operating Results
                                               
Net interest income
  $ 267     $ 1,796     $ 21,972     $ 23,768     $ 5,075     $ 29,110  
Provision for loan losses
                                   
Gain (loss) on sale of loans
    (1,728 )     (3,055 )     (144,053 )     (147,108 )     16,791       (132,045 )
Service fee income (expense)
                            8,288       8,288  
Gain (loss) on MBS
                                   
Other income (expense)
    208       6,297       7,840       14,137       12       14,357  
                                                 
Net revenues (expense)
    (1,253 )     5,038       (114,241 )     (109,203 )     30,166       (80,290 )
Operating expenses
    3,412       55,698       80,797       136,495       30,744       170,651  
Deferral of expenses under SFAS 91
    (2,044 )     (24,528 )     (28,606 )     (53,134 )     (6,555 )     (61,733 )
                                                 
Pre-tax earnings (loss)
    (2,621 )     (26,132 )     (166,432 )     (192,564 )     5,977       (189,208 )
                                                 
Minority interests
    7       46       319       365       232       604  
                                                 
Net earnings (loss)
  $ (1,603 )   $ (15,960 )   $ (101,676 )   $ (117,636 )   $ 3,316     $ (115,923 )
                                                 
Performance Data
                                               
Average interest-earning assets
  $ 84,128     $ 368,401     $ 4,189,758     $ 4,558,159     $ 1,081,362     $ 5,723,649  
Allocated capital
    3,956       26,658       186,160       212,818       135,217       351,991  
Loans produced
    191,562       1,055,633       8,185,935       9,241,568       1,164,215       10,597,345  
Loans sold
    269,865       946,341       12,588,905       13,535,246       1,784,507       15,589,618  
MBR margin(1)
    (0.54 )%     (0.13 )%     (0.97 )%     (0.91 )%     1.23 %     (0.66 )%
ROE
    (161 )%     (238 )%     (217 )%     (219 )%     10 %     (131 )%
Net interest margin
    1.26 %     1.93 %     2.08 %     2.07 %     1.86 %     2.02 %
Average FTE
    241       2,127       2,451       4,578       1,205       6,024  
                                                 
                                                 
                                                 
Three Months Ended December 31, 2006
                                               
Operating Results
                                               
Net interest income
  $ 561     $ 26     $ 21,602     $ 21,628     $ 4,095     $ 26,284  
Provision for loan losses
                                   
Gain (loss) on sale of loans
    6,698       263       85,332       85,595       48,885       141,178  
Service fee income (expense)
                            6,455       6,455  
Gain (loss) on MBS
                                   
Other income (expense)
    135       308             308       188       631  
                                                 
Net revenues (expense)
    7,394       597       106,934       107,531       59,623       174,548  
Operating expenses
    9,714       1,976       99,748       101,724       37,775       149,213  
Deferral of expenses under SFAS 91
    (4,601 )     (74 )     (49,202 )     (49,276 )     (9,285 )     (63,162 )
                                                 
Pre-tax earnings (loss)
    2,281       (1,305 )     56,388       55,083       31,133       88,497  
                                                 
Net earnings (loss)
  $ 1,389     $ (795 )   $ 34,340     $ 33,545     $ 18,748     $ 53,682  
                                                 
Performance Data
                                               
Average interest-earning assets
  $ 177,899     $ 9,002     $ 5,732,379     $ 5,741,381     $ 940,067     $ 6,859,347  
Allocated capital
    8,932       445       300,708       301,153       127,205       437,290  
Loans produced
    397,970       27,155       12,928,786       12,955,941       1,440,515       14,794,426  
Loans sold
    421,098       25,601       12,583,336       12,608,937       1,180,667       14,210,702  
MBR margin(1)
    1.72 %     1.13 %     0.85 %     0.85 %     4.49 %     1.18 %
ROE
    62 %     (709 )%     45 %     44 %     58 %     49 %
Net interest margin
    1.25 %     1.15 %     1.50 %     1.49 %     1.73 %     1.52 %
Average FTE
    297       61       2,890       2,951       1,398       4,646  
Quarter to Quarter Comparison
                                               
% change in net earnings
    (215 )%     N/M       (396 )%     (451 )%     (82 )%     (316 )%
% change in capital
    (56 )%     N/M       (38 )%     (29 )%     6 %     (20 )%
 
 
(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 banking production divisions 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 period that are not included in the amount of total loans sold.


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The following table summarizes the key production drivers for the mortgage broker and banker channel for the periods indicated:
 
                                         
    Three Months Ended  
    December 31,
    December 31,
    Percent
    September 30,
    Percent
 
    2007     2006     Change     2007     Change  
 
Key Production Drivers:
                                       
Active customers(1)
    8,294       7,927       5 %     9,223       (10 )%
Sales personnel
    1,140       1,025       11 %     1,235       (8 )%
Number of regional offices
    16       16             16        
 
 
(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 86% 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 $12.1 billion for the fourth quarter of 2007, down $13.9 billion and $4.7 billion from the fourth quarter of 2006 and third quarter of 2007, respectively. Total loan production, including commercial real estate loans and builder financings, reached $12.3 billion for the fourth quarter of 2007, compared to $26.3 billion a year ago. At December 31, 2007, our total pipeline of SFR mortgage loans in process was $7.5 billion, down 37% from December 31, 2006 but up 1% from September 30, 2007. On January 14, 2008, the MBA issued an estimate of the industry volume for the fourth quarter of 2007 of $463 billion, which represents a 33% and 16% drop from both the fourth quarter of 2006 and third quarter of 2007, respectively. Based on this estimate, our market share is 2.61% for the quarter ended December 31, 2007, down from 3.76% and 3.04% in the quarters ended December 31, 2006 and September 30, 2007, respectively.
 
The decline in our SFR mortgage production from the fourth quarter of 2006 was attributable to the overall drop in mortgage origination volumes resulting from our transition to be primarily a GSE lender and the $9.4 billion decrease in our conduit business. We exited the conduit channel as a response to the disruption in the secondary market. Excluding production from the conduit channel, total SFR production declined $4.5 billion for the fourth quarter year over year. MPG’s mortgage broker and banker channel’s production declined $4.7 billion from the fourth quarter of 2006. Our retail channel generated $1.0 billion in production for the fourth quarter of 2007. The Financial Freedom division saw a 19% decline in its reverse mortgage production from the fourth quarter of 2006, but was up 8% from the third quarter of 2007 as competition intensified in the reverse mortgage market. Compared to the third quarter of 2007, the significant decline in the SFR mortgage loan production of $4.7 billion was attributable to the decrease of $2.5 billion and $2.3 billion in the mortgage broker and banker and conduit, respectively.


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The following summarizes our loan production by division and channel for the periods indicated (dollars in millions):
 
                                                                 
    Three Months Ended     Year Ended  
    December 31,
    December 31,
    Percent
    September 30,
    Percent
    December 31,
    December 31,
    Percent
 
    2007     2006     Change     2007     Change     2007     2006     Change  
 
                                                                 
Production by Division:
                                                               
                                                                 
Mortgage professionals group:
                                                               
                                                                 
Mortgage broker and banker channel(1)
  $ 8,186     $ 12,929       (37 )%   $ 10,720       (24 )%   $ 45,449     $ 47,123       (4 )%
                                                                 
Retail channel
    1,056       7       N/M       546       93 %     2,027       7       N/M  
                                                                 
Consumer direct division
    191       418       (54 )%     263       (27 )%     1,063       1,951       (46 )%
                                                                 
Financial Freedom division
    1,164       1,441       (19 )%     1,080       8 %     4,723       5,024       (6 )%
                                                                 
Servicing retention division
    933       1,010       (8 )%     1,052       (11 )%     4,593       2,698       70 %
                                                                 
Consumer construction division(2)
    499       708       (30 )%     760       (34 )%     2,988       2,937       2 %
                                                                 
                                                                 
Total on-going businesses
    12,029       16,513       (27 )%     14,421       (17 )%     60,843       59,740       2 %
                                                                 
                                                                 
Conduit division
    57       9,416       (99 )%     2,391       (98 )%     16,097       30,101       (47 )%
                                                                 
Home equity division(2)
    3       17       (82 )%     4       (25 )%     39       110       (65 )%
                                                                 
                                                                 
Total discontinued business activities
    60       9,433       (99 )%     2,395       (97 )%     16,136       30,211       (47 )%
                                                                 
                                                                 
Total SFR mortgage loan production
    12,089       25,946       (53 )%     16,816       (28 )%     76,979       89,951       (14 )%
                                                                 
                                                                 
Commercial loan production:
                                                               
                                                                 
Commercial mortgage banking division — on-going businesses
    190             N/A       125       52 %     361             N/A  
                                                                 
Homebuilder division(2) — Discontinued business activities
    22       382       (94 )%     121       (82 )%     976       1,747       (44 )%
                                                                 
                                                                 
Total loan production
  $ 12,301     $ 26,328       (53 )%   $ 17,062       (28 )%   $ 78,316     $ 91,698       (15 )%
                                                                 
                                                                 
Total pipeline of SFR mortgage loans in process at period end
  $ 7,506     $ 11,821       (37 )%   $ 7,421       1 %   $ 7,506     $ 11,821       (37 )%
                                                                 
 
 
(1) The mortgage broker and banker channel includes $1.2 billion, $1.1 billion, and $1.4 billion of production from wholesale inside sales for the quarters ended December 31, 2007 and 2006 and September 30, 2007, respectively, and $5.3 billion and $3.3 billion of production from wholesale inside sales for the years ended December 31, 2007 and 2006, 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 periods indicated (dollars in millions):
 
                                                                 
    Three Months Ended     Year Ended  
    December 31,
    December 31,
    Percent
    September 30,
    Percent
    December 31,
    December 31,
    Percent
 
    2007     2006     Change     2007     Change     2007     2006     Change  
 
                                                                 
Production by Product Type:
                                                               
                                                                 
Standard first mortgage products:
                                                               
                                                                 
Prime
  $ 10,030     $ 20,978       (52 )%   $ 13,632       (26 )%   $ 62,917     $ 71,403       (12 )%
                                                                 
Subprime
    186       886       (79 )%     596       (69 )%     2,617       2,674       (2 )%
                                                                 
                                                                 
Total standard first mortgage products (S&P evaluated)
    10,216       21,864       (53 )%     14,228       (28 )%     65,534       74,077       (12 )%
                                                                 
Specialty consumer home mortgage products:
                                                               
                                                                 
HELOCs(1)/Seconds
    280       1,856       (85 )%     637       (56 )%     3,496       7,199       (51 )%
                                                                 
Reverse mortgages
    1,164       1,441       (19 )%     1,080       8 %     4,723       5,024       (6 )%
                                                                 
Consumer construction(1)
    385       785       (51 )%     871       (56 )%     3,182       3,651       (13 )%
                                                                 
Government — FHA/VA(2)
    44             N/A             N/A       44             N/A  
                                                                 
                                                                 
Subtotal SFR mortgage production
    12,089       25,946       (53 )%     16,816       (28 )%     76,979       89,951       (14 )%
                                                                 
Commercial loan products:
                                                               
                                                                 
Commercial real estate
    190             N/A       125       52 %     361             N/A  
                                                                 
Builder construction commitments(1)
    22       382       (94 )%     121       (82 )%     976       1,747       (44 )%
                                                                 
                                                                 
Total production
  $ 12,301     $ 26,328       (53 )%   $ 17,062       (28 )%   $ 78,316     $ 91,698       (15 )%
                                                                 
                                                                 
Total S&P lifetime loss estimate(3)
    0.45 %     1.88 %             0.72 %             1.14 %     1.90 %        
 
 
(1) Amounts represent total commitments.
 
(2) Amounts represent loans insured by the Federal Housing Administration (“FHA”) and loans guaranteed by the Veterans Administration (“VA”).
 
(3) 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.
 
The above 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 that further classification may not accurately reflect the credit quality of loans produced implied through such classification.
 
Loan Sale and Distribution
 
The following table shows the various channels through which loans were distributed for the Company during the periods indicated (dollars in millions):
 
                                         
    Three Months Ended     Year Ended  
    December 31,
    December 31,
    September 30,
    December 31,
    December 31,
 
    2007     2006     2007     2007     2006  
 
Distribution of Loans by Channel:
                                       
Sales of GSE equivalent loans
    75 %     24 %     66 %     48 %     20 %
Private-label securitizations
    25 %     33 %     33 %     34 %     40 %
Whole loan sales, servicing retained
          41 %           17 %     38 %
Whole loan sales, servicing released
          2 %     1 %     1 %     2 %
                                         
Total loan sales percentage
    100 %     100 %     100 %     100 %     100 %
                                         
Total loan sales
  $ 13,425     $ 23,417     $ 13,009     $ 71,164     $ 79,049  
                                         
 
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 the GSEs increased to 75% of total loan distribution for the fourth quarter of 2007, up from 24% and 66% for the fourth quarter of 2006 and third quarter of 2007, respectively. We expect that a very high percentage of our loan sales will be to the GSEs until the private MBS market recovers.


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Table of Contents

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). The calculation of gain (loss) on sales of loans included the retention of $194.8 million of MSRs and $120.9 million of other retained assets, consisting of investment-grade securities of $103.9 million and non-investment grade and residual securities of $17.0 million during the three months ended December 31, 2007. During the three months ended December 31, 2007, assets previously retained generated cash flows of $224.2 million. More information on the valuation assumptions related to our retained assets can be found in Table 14 “Valuation of MSRs, Interest-Only, Prepayment Penalty, and Residual Securities” of Appendix A.
 
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, primarily lot loans and home equity products, is included in the MBR margin calculation.
 
The following table summarizes the amount of loans sold and the MBR margin during the periods indicated (dollars in millions):
 
                                                                 
    Three Months Ended     Year Ended  
    December 31,
    December 31,
    Percent
    September 30,
    Percent
    December 31,
    December 31,
    Percent
 
    2007     2006     Change     2007     Change     2007     2006     Change  
 
Total loans sold
  $ 13,425     $ 23,417       (43 )%   $ 13,009       3 %   $ 71,164     $ 79,049       (10 )%
MBR margin after production hedging
    0.77 %     1.26 %     (39 )%     0.48 %     60 %     0.99 %     1.41 %     (30 )%
MBR margin after credit costs
    (1.88 )%     1.12 %     (268 )%     (1.26 )%     49 %           1.28 %      
Net MBR margin
    (2.14 )%     0.91 %     (335 )%     (1.54 )%     39 %     (0.22 )%     1.06 %     (121 )%
 
For more details on our MBR margin see Table 7 “MBR Margin” of Appendix A.
 
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 the fourth quarter of 2007, the value of 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 quarter. Actual prepayment speeds have declined due to the impact of tighter guidelines on the available mortgage loans and declining home prices.
 
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


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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. Refer to Table 14 “Valuation of MSRs, Interest-Only, Prepayment Penalty, and Residual Securities” of Appendix A for further detail on the valuation assumptions.
 
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 but remained relatively flat compared to $2.5 billion at September 30, 2007.


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The following tables provide additional detail on the results for the mortgage servicing division for the periods indicated (dollars in thousands):
 
                         
    Mortgage
          Total
 
    Servicing
    Servicing
    Mortgage
 
    Rights
    Retention
    Servicing
 
    Channel     Channel     Division  
Three Months Ended December 31, 2007
                       
Operating Results
                       
Net interest income (expense)
  $ (18,306 )   $ 2,289     $ (16,017 )
Gain (loss) on sale of loans
    109       15,762       15,871  
Service fee income (expense)
    92,111             92,111  
Gain (loss) on MBS
    (5,617 )           (5,617 )
Other income (expense)
    (686 )     1,506       820  
                         
Net revenues (expense)
    67,611       19,557       87,168  
Operating expenses
    13,106       11,248       24,354  
Deferral of expenses under SFAS 91
          (2,811 )     (2,811 )
                         
Pre-tax earnings (loss)
    54,505       11,120       65,625  
                         
Minority interests
    562       65       627  
                         
Net earnings (loss)
  $ 32,632     $ 6,707     $ 39,339  
                         
Performance Data
                       
Average interest-earning assets
  $ 322,139     $ 885,184     $ 1,207,323  
Allocated capital
    327,505       37,654       365,159  
Loans produced
          932,926       932,926  
Loans sold
          978,021       978,021  
MBR margin
    N/A       1.61 %     1.62 %
ROE
    40 %     71 %     43 %
Net interest margin
    N/A       1.03 %     N/A  
Average FTE
    94       165       259  
                         
Three Months Ended December 31, 2006
                       
Operating Results
                       
Net interest income (expense)
  $ (6,400 )   $ 1,751     $ (4,649 )
Provision for loan losses
                 
Gain (loss) on sale of loans
    574       11,214       11,788  
Service fee income (expense)
    24,348             24,348  
Gain (loss) on MBS
    5,906             5,906  
Other income (expense)
    1,421       1,852       3,273  
                         
Net revenues (expense)
    25,849       14,817       40,666  
Operating expenses
    9,405       9,853       19,258  
Deferral of expenses under SFAS 91
          (2,925 )     (2,925 )
                         
Pre-tax earnings (loss)
    16,444       7,889       24,333  
                         
Net earnings (loss)
  $ 10,014     $ 4,804     $ 14,818  
                         
Performance Data
                       
Average interest-earning assets
  $ 201,741     $ 514,094     $ 715,835  
Allocated capital
    267,225       24,016       291,241  
Loans produced
          1,009,730       1,009,730  
Loans sold
          655,085       655,085  
MBR margin
    N/A       1.71 %     1.80 %
ROE
    15 %     79 %     20 %
Net interest margin
    N/A       N/A       N/A  
Average FTE
    95       179       274  
Quarter to Quarter Comparison
                       
% change in net earnings
    226 %     40 %     165 %
% change in capital
    23 %     57 %     25 %
 
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%; and $173.9 billion at September 30, 2007, with a weighted average coupon of 7.04%.


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The following table provides the activity in the servicing portfolios for the periods indicated (dollars in millions):
 
                                         
    Three Months Ended     Year Ended  
    December 31,
    December 31,
    September 30,
    December 31,
    December 31,
 
    2007     2006     2007     2007     2006  
 
Unpaid principal balance of loans serviced at beginning of period
  $ 173,915     $ 124,395     $ 167,710     $ 139,817     $ 84,495  
Additions
    13,967       23,415       13,377       72,613       80,237  
Clean-up calls exercised
                      (153 )     (31 )
Loan payments and prepayments
    (6,158 )     (7,993 )     (7,172 )     (30,553 )     (24,884 )
                                         
Unpaid principal balance of loans serviced at end of period
  $ 181,724     $ 139,817     $ 173,915     $ 181,724     $ 139,817  
                                         
 
The following tables also provide additional information related to the servicing portfolio as of the dates indicated:
 
                         
    December 31,
    December 31,
    September 30,
 
    2007     2006     2007  
 
By Product Type:
                       
Fixed-rate mortgages
    36 %     35 %     37 %
Intermediate term fixed-rate loans
    35 %     30 %     35 %
Pay option adjustable-rate mortgages (“ARMs”)
    17 %     23 %     16 %
Reverse mortgages
    10 %     9 %     9 %
HELOCs
    1 %     2 %     2 %
Other
    1 %     1 %     1 %
                         
Total
    100 %     100 %     100 %
                         
Additional Information(1):
                       
Weighted average FICO(2)
    702       703       705  
Weighted average original loan-to-value (“LTV”) ratio(3)
    73 %     73 %     73 %
Average original loan size (in thousands)
    247       232       243  
Percent of portfolio with prepayment penalty
    33 %     42 %     37 %
Portfolio delinquency (% of unpaid principal balance)(4)
    7.31 %     5.02 %     6.77 %
By Geographic Distribution:
                       
California
    43 %     43 %     43 %
Florida
    8 %     8 %     8 %
New York
    8 %     8 %     8 %
New Jersey
    4 %     4 %     4 %
Virginia
    4 %     4 %     4 %
Others
    33 %     33 %     33 %
                         
Total
    100 %     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 (“CLTV”) 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 (1) the ROEs exceed the cost of both core and risk-based capital, or (2) 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 warehouse lending and consumer construction. These investing activities provide core spread income and generally, a more stable return on equity.
 
In addition to the $95.0 million net loss in our mortgage banking segment, our thrift segment reported a $186.4 million net loss in the fourth quarter of this year 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 fourth quarter of 2007 totaled $507.2 million compared with only $15.4 million in credit costs in the thrift segment in last year’s fourth quarter. Although all the divisions in the thrift segment incurred higher credit costs this quarter, the majority of the increase was concentrated in the non-investment grade and residual securities divisions.


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The following tables provide detail on the results for divisions of our thrift segment for the periods 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  
Three Months Ended December 31, 2007
                                                       
Operating Results
                                                       
Net interest income
  $ 14,541     $ 15,169     $ 29,710     $ 42,523     $ 13,721     $ 628     $ 86,582  
Provision for loan losses
                      (111,064 )     (30,411 )           (141,475 )
Gain (loss) on sale of loans
                      105       7,312             7,417  
Service fee income (expense)
                                         
Gain (loss) on MBS
    (31,892 )     (199,275 )     (231,167 )           (827 )           (231,994 )
Other income (expense)
          (3 )     (3 )     559       4,569       173       5,298  
                                                         
Net revenues (expense)
    (17,351 )     (184,109 )     (201,460 )     (67,877 )     (5,636 )     801       (274,172 )
Operating expenses
    346       919       1,265       14,076       14,685       760       30,786  
Deferral of expenses under SFAS 91
                            (920 )           (920 )
                                                         
Pre-tax earnings (loss)
    (17,697 )     (185,028 )     (202,725 )     (81,953 )     (19,401 )     41       (304,038 )
                                                         
Minority interests
    176       324       500       492       208       7       1,207  
                                                         
Net earnings (loss)
  $ (10,953 )   $ (113,006 )   $ (123,959 )   $ (50,401 )   $ (12,023 )   $ 18     $ (186,365 )
                                                         
Performance Data
                                                       
Average interest-earning assets
  $ 6,059,178     $ 368,355     $ 6,427,533     $ 9,090,342     $ 2,791,238     $ 60,221     $ 18,369,334  
Allocated capital
    102,539       188,880       291,419       286,542       121,102       4,113       703,176  
Loans produced
                            498,691             498,691  
Loans sold
                      2,201,671       904,641             3,106,312  
ROE
    (42 )%     (237 )%     (169 )%     (70 )%     (39 )%     2 %     (105 )%
Net interest margin, thrift. 
    0.95 %     16.34 %     1.83 %     1.86 %     1.95 %     4.14 %     1.87 %
Efficiency ratio
    (2 )%           (1 )%     33 %     56 %     95 %     (23 )%
Average FTE
    3       11       14       13       336       28       391  
                                                         
Three Months Ended December 31, 2006
                                                       
Operating Results
                                                       
Net interest income
  $ 5,678     $ 10,378     $ 16,056     $ 14,555     $ 11,586     $ 1,312     $ 43,509  
Provision for loan losses
                      (4,500 )     (1,036 )     (92 )     (5,628 )
Gain (loss) on sale of loans
                      2,068       8,853             10,921  
Service fee income (expense)
                                         
Gain (loss) on MBS
    91       (4,869 )     (4,778 )           (83 )           (4,861 )
Other income (expense)
                      447       4,593       531       5,571  
                                                         
Net revenues (expense)
    5,769       5,509       11,278       12,570       23,913       1,751       49,512  
Operating expenses
    302       617       919       1,700       17,069       1,042       20,730  
Deferral of expenses under SFAS 91
                            (1,924 )           (1,924 )
                                                         
Pre-tax earnings (loss)
    5,467       4,892       10,359       10,870       8,768       709       30,706  
                                                         
Net earnings (loss)
  $ 3,329     $ 2,979     $ 6,308     $ 6,620     $ 5,340     $ 432     $ 18,700  
                                                         
Performance Data
                                                       
Average interest-earning assets
  $ 3,876,837     $ 255,006     $ 4,131,843     $ 6,548,868     $ 2,605,291     $ 187,876     $ 13,473,878  
Allocated capital
    73,452       130,791       204,243       246,883       127,789       14,983       593,898  
Loans produced
                            708,443             708,443  
Loans sold
                      167,451       541,054             708,505  
ROE
    18 %     9 %     12 %     11 %     17 %     11 %     12 %
Net interest margin, thrift. 
    0.58 %     16.15 %     1.54 %     0.88 %     1.76 %     2.77 %     1.28 %
Efficiency ratio
    5 %     11 %     8 %     10 %     61 %     57 %     34 %
Average FTE
    4       6       10       12       404       30       456  
Quarter to Quarter Comparison
                                                       
% change in net earnings
    (429 )%     N/M       N/M       N/M       (325 )%     (96 )%     N/M  
% change in capital
    40 %     44 %     43 %     16 %     (5 )%     (73 )%     18 %


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The following tables and discussion 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 divisions.
 
MORTGAGE-BACKED SECURITIES DIVISION
 
The following table provides the details of the MBS portfolio as of the dates indicated (dollars in thousands):
 
                                                                         
    December 31, 2007     December 31, 2006     September 30, 2007  
    Trading     AFS     Total     Trading     AFS     Total     Trading     AFS     Total  
 
Mortgage Banking Segment:
                                                                       
AAA-rated agency securities
  $     $     $     $     $ 2,915     $ 2,915     $ 350,694     $     $ 350,694  
AAA-rated and agency interest-only securities
    59,844             59,844       66,581             66,581       71,901             71,901  
AAA-rated principal-only securities
    88,024             88,024       38,478             38,478       72,488             72,488  
Prepayment penalty and other securities
    79,678             79,678       93,176             93,176       83,205             83,205  
                                                                         
Total Mortgage Banking
    227,546             227,546       198,235       2,915       201,150       578,288             578,288  
                                                                         
Thrift segment:
                                                                       
AAA-rated non-agency securities
    510,371       5,543,306       6,053,677       43,957       4,604,489       4,648,446       152,773       3,762,877       3,915,650  
AAA-rated agency securities
          45,296       45,296             62,260       62,260       45,414       47,408       92,822  
AAA-rated and agency interest-only securities
                      6,989             6,989                    
Prepayment penalty and other securities
    2,349             2,349       4,400             4,400       5,034             5,034  
Other investment grade securities
    275,691       451,798       727,489       29,015       160,238       189,253       255,390       468,766       724,156  
Other non-investment grade securities
    93,859       61,889       155,748       41,390       38,784       80,174       152,340       37,939       190,279  
Non-investment grade residual securities
    112,727       3,687       116,414       218,745       31,828       250,573       218,405       7,410       225,815  
                                                                         
Total thrift 
    994,997       6,105,976       7,100,973       344,496       4,897,599       5,242,095       829,356       4,324,400       5,153,756  
                                                                         
Total mortgage-backed securities
  $ 1,222,543     $ 6,105,976     $ 7,328,519     $ 542,731     $ 4,900,514     $ 5,443,245     $ 1,407,644     $ 4,324,400     $ 5,732,044  
                                                                         
 
AAA-rated MBS represented 85%, 89% and 79% of the total portfolio at December 31, 2007 and 2006 and September 30, 2007, respectively. These securities had an expected weighted average life of 3.0 years, 2.9 years and 3.2 years at December 31, 2007 and 2006 and September 30, 2007, respectively. Due to downgrades of investment grade securities in January 2008, the Company anticipates an increase in non-investment grade securities.
 
In the fourth quarter of 2007, the Bank securitized $3.32 billion of mortgage loans. The Bank retained $1.92 billion of the securities and sold $1.40 billion. Of the $1.92 billion retained securities recorded as MBS, $1.90 billion and $20 million were classified as available for sale and trading, respectively.
 
SFR MORTGAGE LOANS HFI DIVISION
 
The SFR mortgage loans HFI portfolio is comprised primarily of interest-only loans and adjustable-rate mortgage loans.
 
At December 31, 2007, we have $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 and $1.1 billion, or 22% of the portfolio, at September 30, 2007. 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% and 88% at December 31, 2006 and September 30, 2007, respectively. The net increase in unpaid principal balance due to negative amortization was $55.7 million and $75.5 million for the three months and year ended December 31, 2007, respectively, which approximated the deferred interest recognized for the periods.
 
The Company transferred mortgage loans in the fourth quarter of 2007 with an original cost basis of $10.9 billion to held for investment 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 at September 30, 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 the same quarter in 2007, the Bank securitized $3.32 billion, of which $2.04 billion of mortgage loans came from SFR mortgage loans HFI division.


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The following tables provide 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,
    December 31,
    September 30,
 
    2007     2006     2007  
 
Outstanding balance (book value)(1)
  $ 11,411,464     $ 6,519,340     $ 4,913,471  
Average loan size
    270       310       344  
Non-performing loans
    6.47 %     1.09 %     3.64 %
Estimated average life in years(2)
    2.4       2.6       3.5  
Annualized yield
    7.03 %     6.01 %     6.32 %
Percent of loans with active prepayment penalty
    43 %     34 %     34 %
By Product Type:
                       
Fixed-rate mortgages
    15 %     5 %     6 %
Intermediate term fixed-rate loans
    15 %     15 %     16 %
Interest-only loans
    43 %     60 %     54 %
Pay option ARMs
    26 %     18 %     22 %
Other
    1 %     2 %     2 %
                         
Total
    100 %     100 %     100 %
Additional Information:
                       
Average FICO score
    693       716       712  
Original average LTV ratio
    76 %     73 %     73 %
Current average LTV ratio(3)
    77 %     61 %     70 %
Geographic distribution of top five states:
                       
Southern California
    30 %     32 %     33 %
Northern California
    15 %     20 %     22 %
                         
Total California
    45 %     52 %     55 %
Florida
    9 %     6 %     6 %
New York
    7 %     4 %     5 %
New Jersey
    3 %     2 %     2 %
Maryland
    3 %     2 %     2 %
Other
    33 %     34 %     30 %
                         
Total
    100 %     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) Current average LTV ratio is estimated based on the Office of Federal Housing Enterprise Oversight House Price Index Metropolitan Statistical Area data for the third quarter of 2007 on a loan level basis.


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CONSUMER CONSTRUCTION DIVISION
 
Our consumer construction division provides construction financing for individual consumers who want to build a new primary residence or second home. The primary product is a construction-to-permanent 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 suspended all new construction-to-permanent production on January 31, 2008 to help manage the Company’s balance sheet. Our consumer construction division had previously suspended lot and single spec production in the fourth quarter of 2007.
 
During the fourth quarter of 2007, we entered into new consumer construction commitments of $385 million, which is a decrease of 51%, or $400 million, from the fourth quarter of 2006 and a decrease of 56%, or $486 million, from the third quarter of 2007. Approximately 74% of new commitments are generated through mortgage broker customers of the MPG and the remaining 26% of new commitments are retail originations. Consumer construction loans outstanding at December 31, 2007 increased 3% from December 31, 2006 and decreased 12% from September 30, 2007.
 
Since the introduction of a monthly adjusting construction period ARM product in the second quarter of 2006, measured by commitment, the percentage of adjustable-rate loans in our portfolio has increased to 72% at December 31, 2007 from 29% and 61% at December 31, 2006 and September 30, 2007, respectively. The ratio of non-performing loans increased to 3.31% of the portfolio at December 31, 2007, compared to 1.14% and 2.02% at December 31, 2006 and September 30, 2007, respectively. As a result, we increased the provision for loan losses to $30.4 million for the fourth quarter of 2007 and increased the percentage of allowance for loan losses to book value to 1.38% at the end of the quarter.


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Information on our consumer construction portfolio is presented in the following tables as of the dates indicated (dollars in thousands):
 
                         
    December 31,
    December 31,
    September 30,
 
    2007     2006     2007  
 
Outstanding balance (book value)
  $ 2,343,036     $ 2,276,133     $ 2,658,292  
Total commitments
    3,503,790       3,600,454       4,044,659  
Average loan commitment(1)
    570       474       478  
Non-performing loans
    3.31 %     1.14 %     2.02 %
By Product Type:
                       
Fixed-rate loans
    28 %     71 %     39 %
Adjustable-rate loans
    72 %     29 %     61 %
                         
      100 %     100 %     100 %
                         
Additional Information:
                       
Average LTV ratio(2)
    73 %     73 %     74 %
Average FICO score
    722       718       721  
Geographic distribution of top five states:
                       
Southern California
    30 %     28 %     29 %
Northern California
    12 %     15 %     13 %
                         
Total California
    42 %     43 %     42 %
Florida
    7 %     9 %     7 %
Washington
    4 %     4 %     4 %
New York
    4 %     4 %     4 %
Arizona
    4 %     3 %     4 %
Other
    39 %     37 %     39 %
                         
Total
    100 %     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 estimated appraised value of the completed project compared to the commitment amount at the date indicated.
 
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 production divisions regularly sell loans to our SFR mortgage division. These transactions are recorded at arms-length in our segment results resulting in intercompany gain on sale in the production divisions and a premium in the SFR mortgage division that is amortized over the life of the loan. Both the gain and the premium amortization are eliminated in consolidation.
 
The mortgage production division and 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/swap rates. Tighter spreads benefit the mortgage bank 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 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


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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 tables provide additional detail on deposits, treasury and eliminations for the periods indicated (dollars in thousands):
 
                                                 
                Eliminations        
                      Interdivision
             
                Interdivision
    Hedge
             
    Deposits     Treasury     Loan Sales(1)     Transactions     Other     Total  
 
Three Months Ended December 31, 2007
                                               
Operating Results
                                               
Net interest income
  $     $ 11,074     $ 9,025     $     $ 7,197     $ 27,296  
Provision for loan losses
                                   
Gain (loss) on sale of loans
                (29,794 )     (35,690 )     979       (64,505 )
Service fee income (expense)
                      35,690       34,561       70,251  
Gain (loss) on MBS
                            (45,655 )     (45,655 )
Other income (expense)
    1,217       233                   (655 )     795  
                                                 
Net revenues (expense)
    1,217       11,307       (20,769 )           (3,573 )     (11,818 )
Operating expenses
    7,393       13,774                   (3,573 )     17,594  
Deferral of expenses under SFAS 91
                                   
                                                 
Pre-tax earnings (loss)
    (6,176 )     (2,467 )     (20,769 )                 (29,412 )
                                                 
Minority interests
    3       7,630                         7,633  
                                                 
Net earnings (loss)
  $ (3,764 )   $ (9,132 )   $ (12,559 )   $     $     $ (25,455 )
                                                 
Three Months Ended December 31, 2006
                                               
Operating Results
                                               
Net interest income
  $     $ 9,277     $ 9,619     $     $ 4,199     $ 23,095  
Provision for loan losses
                                   
Gain (loss) on sale of loans
                (19,365 )                 (19,365 )
Service fee income (expense)
                1,097             (9,332 )     (8,235 )
Gain (loss) on MBS
                843                   843  
Other income (expense)
    907       167                   (1,568 )     (494 )
                                                 
Net revenues (expense)
    907       9,444       (7,806 )           (6,701 )     (4,156 )
Operating expenses
    7,361       11,797                   (5,550 )     13,608  
Deferral of expenses under SFAS 91
                            (655 )     (655 )
                                                 
Pre-tax earnings (loss)
    (6,454 )     (2,353 )     (7,806 )           (496 )     (17,109 )
                                                 
Net earnings (loss)
  $ (3,930 )   $ (1,433 )   $ (4,754 )   $     $ 6,219     $ (3,898 )
                                                 
 
 
(1) Includes loans sold of $10.0 billion and $2.0 billion for the three months ended December 31, 2007 and 2006, respectively.
 
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 decreased 2% from a loss of $28.2 million in the fourth quarter of 2006 to $27.7 million in fourth quarter of 2007.
 
DISCONTINUED BUSINESS ACTIVITIES
 
As conditions in the U.S. mortgage market have deteriorated, we have exited certain production divisions and are reporting them in a separate category in our segment reporting. These exited production divisions include conduit, homebuilder and home equity. Of the $862.9 million in total credit costs we reported in the fourth quarter of 2007, $249.4 million were in these discontinued businesses driving the total after-tax loss of $174.7 million for these discontinued businesses in the current quarter. These activities are not considered discontinued operations pursuant to GAAP.


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The following tables provide details on the results of our discontinued business activities for the periods indicated (dollars in thousands):
 
                                         
    Discontinued Business Activities  
          Home
                   
    Conduit
    Equity
    Homebuilder
             
    Channel     Division     Division     Other     Total  
 
Three Months Ended December 31, 2007
                                       
Operating Results
                                       
Net interest income
  $ 4,953     $ 5,728     $ 3,259     $ 419     $ 14,359  
Provision for loan losses
          (28,500 )     (98,953 )     (450 )     (127,903 )
Gain (loss) on sale of loans
    (74,150 )     (69,245 )                 (143,395 )
Service fee income (expense)
          869                   869  
Gain (loss) on MBS
          (11,085 )                 (11,085 )
Other income (expense)
    (11 )     1,654       (981 )           662  
                                         
Net revenues (expense)
    (69,208 )     (100,579 )     (96,675 )     (31 )     (266,493 )
Operating expenses
    11,175       3,567       5,552       (59 )     20,235  
Deferral of expenses under SFAS 91
          (36 )     (634 )           (670 )
                                         
Pre-tax earnings (loss)
    (80,383 )     (104,110 )     (101,593 )     28       (286,058 )
                                         
Minority interests
    133       234       78       4       449  
                                         
Net earnings (loss)
  $ (49,086 )   $ (63,637 )   $ (61,948 )   $ 13     $ (174,658 )
                                         
Performance Data
                                       
Average interest-earning assets
  $ 1,620,229     $ 1,866,137     $ 1,201,068     $ 29,399     $ 4,716,833  
Allocated capital
    77,396       136,233       45,815       2,438       261,882  
Loans produced
    57,042       3,369       22,158             82,569  
Loans sold
    3,699,180       67,994                   3,767,174  
MBR margin
    (1.87 )%     N/A       N/A       N/A       (3.67 )%
ROE
    (252 )%     (185 )%     N/M       2 %     (265 )%
Net interest margin
    1.21 %     1.22 %     1.08 %     5.65 %     1.21 %
Efficiency ratio
    N/A       (5 )%     216 %     (14 )%     (14 )%
Average FTE
    64       77       106             247  
                                         
Three Months Ended December 31, 2006
                                       
Operating Results
                                       
Net interest income
  $ 22,383     $ 8,600     $ 15,460     $ 406     $ 46,849  
Provision for loan losses
          (1,800 )     (1,100 )     (425 )     (3,325 )
Gain (loss) on sale of loans
    13,975       6,474                   20,449  
Service fee income (expense)
          (445 )                 (445 )
Gain (loss) on MBS
          (6,017 )                 (6,017 )
Other income (expense)
    (136 )     2,078       552             2,494  
                                         
Net revenues (expense)
    36,222       8,890       14,912       (19 )     60,005  
Operating expenses
    8,606       4,420       5,832       52       18,910  
Deferral of expenses under SFAS 91
          (211 )     (1,770 )           (1,981 )
                                         
Pre-tax earnings (loss)
    27,616       4,681       10,850       (71 )     43,076  
                                         
Net earnings (loss)
  $ 16,818     $ 2,851     $ 6,608     $ (43 )   $ 26,234  
                                         
Performance Data
                                       
Average interest-earning assets
  $ 5,555,975     $ 1,794,929     $ 1,141,871     $ 37,129     $ 8,529,904  
Allocated capital
    230,960       140,692       107,536       3,380       482,568  
Loans produced
    9,416,480       17,177       381,760             9,815,417  
Loans sold
    9,124,889       767,620                   9,892,509  
MBR margin
    0.40 %     N/A       N/A       N/A       N/A  
ROE
    29 %     8 %     24 %     (5 )%     22 %
Net interest margin
    1.60 %     1.90 %     5.37 %     4.34 %     2.18 %
Efficiency ratio
    N/A       39 %     25 %     13 %     27 %
Average FTE
    161       80       118             359  
Quarter to Quarter Comparison
                                       
% change in net earnings
    (392 )%     N/M       N/M       130 %     N/M  
% change in equity
    (66 )%     (3 )%     (57 )%     (28 )%     (46 )%


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HOME EQUITY DIVISION
 
The home equity division provided HELOC and closed-end second mortgages nationwide through our mortgage broker and banker and retail channels. We have suspended new originations in this division as a response to the present market condition.
 
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 $280.2 million of new HELOC commitments through our mortgage banking segment and internal channels during the fourth quarter of 2007, sold $68.0 million and realized a net loss on sale of $82.6 million primarily due to lower of cost or market (“LOCOM”) adjustments of $80.0 million. During the fourth quarter of 2006, we produced $839.1 million of HELOC loans and sold $767.6 million with a corresponding net gain on sale of $6.2 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. 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,
    December 31,
    September 30,
 
    2007     2006     2007  
 
Outstanding balance (book value)
  $ 1,628,282     $ 656,714     $ 1,509,125  
Total commitments(1)
    3,239,902       2,211,298       3,149,353  
Average spread over prime
    1.16 %     1.39 %     1.23 %
Average FICO score
    736       737       729  
Average CLTV ratio(2)
    77 %     77 %     77 %
 
Additional Information on HELOC Portfolio
 
                                         
          Average Loan
          Current
    30+ Days
 
December 31, 2007
  Outstanding
    Commitment
    Average Spread
    Average
    Delinquency
 
CLTV Ratio
  Balance     Balance     Over Prime     FICO     Percentage(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 %
                                         
December 31, 2006
                             
CLTV Ratio
                             
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 CLTV ratio 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.


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HOMEBUILDER DIVISION
 
The homebuilder division has ceased new originations in response to the extreme disruptions in the housing and mortgage markets. We also 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, additional downgrades, additional provisions for loan losses, and charge-offs relating to this portfolio are anticipated.
 
The rapid deterioration in the California and Florida real estate markets and the disruption in the mortgage market 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, and up from $421.2 million, or 36% of outstandings at September 30, 2007. At December 31, 2007, non-performing loans for the builder construction portfolio rose to $480.2 million, from $9.0 million at December 31, 2006 and $106.1 million at September 30, 2007. 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 and 1,424 unsold units at September 30, 2007. The weighted average LTV ratio of this portfolio increased to 82% at December 31, 2007 compared to 73% at December 31, 2006 and 76% at September 30, 2007.
 
The increase in non-performing and classified assets resulted in a provision to the allowance for loan losses of $99.0 million for the fourth quarter of 2007, or 8.21% of average loans for the period, up from $1.1 million, or 0.10% of average loans, for the fourth quarter of 2006, and up from $78.2 million, or 6.0% of average loans, for the third quarter of 2007. The total allowance for loan losses increased to $198.6 million, or 16.66% of book value of total loans, at December 31, 2007, up from $20.5 million or 1.79% of book value of total loans at December 31, 2006, and up from $99.6 million or 8.48% at September 30, 2007. There were no charge-offs and REO in 2007 but we believe we will have charge-offs and REO in 2008.


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Information on our homebuilder portfolio is presented in the following tables as of the dates indicated (dollars in thousands):
 
                         
    December 31,
    December 31,
    September 30,
 
    2007     2006     2007  
 
Outstanding balance (book value)
  $ 1,192,093     $ 1,144,835     $ 1,175,473  
Total commitments
    1,662,060       2,010,727       1,783,395  
Average loan commitments
    8,480       10,810       8,574  
Percentage of homes under construction or completed that are sold
    29.95 %     37.07 %     33.91 %
Non-performing loans
    40.28 %     0.78 %     9.03 %
Allowance for loan losses as a percentage of book value
    16.66 %     1.79 %     8.48 %
Additional Information:
                       
Average LTV ratio(1)
    82 %     73 %     76 %
Geographic distribution of top five states:
                       
Southern California
    37 %     41 %     37 %
Northern California
    29 %     19 %     29 %
                         
Total California
    66 %     60 %     66 %
Florida
    10 %     11 %     11 %
Illinois
    7 %     9 %     6 %
Oregon
    4 %     6 %     4 %
Arizona
    3 %     4 %     3 %
Other
    10 %     10 %     10 %
                         
Total
    100 %     100 %     100 %
                         
 
 
(1) The average LTV ratio is based on the estimated appraised value of the completed project compared to the commitment amount at the date indicated.
 
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.
 
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 Office of Thrift Supervision (“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.


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CAPITAL
 
The Bank is subject to regulatory capital regulations administered by the federal banking agencies. As of December 31, 2007, the Bank met all of the requirements of a “well-capitalized” institution under the general regulatory capital regulations.
 
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 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 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 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 Ratios
 
The following presents the Bank’s actual and required capital ratios and the minimum required capital ratios to be categorized as “well-capitalized” as of the period indicated (dollars in thousands):
 
                                 
    Capital Ratios  
    Tangible     Tier 1 (core)     Tier 1 Risk-Based     Total Risk-Based  
 
December 31, 2007:
                               
As reported pre-subprime risk-weighting
    6.24 %     6.24 %     9.56 %     10.81 %
Adjusted for additional subprime risk weighting
    6.24 %     6.24 %     9.28 %     10.50 %
Well-capitalized minimum requirement
    2.00 %     5.00 %     6.00 %     10.00 %
Excess over well-capitalized minimum requirement
  $ 1,367,732     $ 399,280     $ 655,082     $ 100,400  
 
The OTS guidance for subprime lending programs requires a lender to quantify the additional risks in its subprime lending activities and determine the appropriate amounts of allowances for loan losses and capital it needs to offset those risks. We generally classify all non-GSE loans in a first lien position with a FICO score less than 620 and all non-GSE loans in a second lien position with a FICO score less than 660 as subprime. We report our subprime loan calculation in an addendum to the Thrift Financial Report that we file quarterly with the OTS. All subprime loans HFI, and subprime loans HFS, which are either delinquent or more than 90 days old since origination, are supported by capital two times that of similar prime loans. These subprime loans totaled $794.7 million at December 31, 2007. The impact of the additional risk-weighting criteria related to subprime loans had the effect of reducing our total risk-based capital by 31 basis points from 10.81% to 10.50%.
 
We believe that, under current regulations, the Bank will continue to meet its “well-capitalized” minimum capital requirements in the foreseeable future. The Bank’s regulatory capital compliance could be impacted by a number of factors, such as changes to applicable regulations, adverse action by our regulators, changes in our mix of assets, decline in real estate values, interest rate fluctuations, loan loss provisions and credit losses, or significant changes in the economy in areas where we have most of our loans, or future disruptions in the secondary mortgage market. Any of these factors could cause actual future results to vary from anticipated future results and consequently could have an adverse impact on the ability of the Bank to meet its future minimum capital requirements. We are currently forecasting that our balance sheet size will decline and our capital ratios will increase over the course of 2008 as we execute on our revised business model of primarily GSE lending.


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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 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.
 
The following provides information on the core and risk-based capital ratios for the two primary segments and each of their operating divisions for the period indicated (dollars in thousands):
 
                                                                                 
    Total Assets     Core     Risk-Based  
          % of
    Avg.
    % of
                Avg.
    % of
             
    Average
    Total
    Allocated
    Total
    Capital/
          Allocated
    Total
    Capital/
       
Three Months Ended December 31, 2007
  Assets     Assets     Capital     Capital     Assets     ROE     Capital     Capital     Assets     ROE  
 
Mortgage Banking:
                                                                               
Consumer Direct
  $ 89,503       0.3 %   $ 3,261       0.2 %     3.6 %     (196 )%   $ 3,956       0.2 %     4.4 %     (161 )%
Retail
    398,472       1.1 %     13,786       0.8 %     3.5 %     (462 )%     26,658       1.5 %     6.7 %